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NO.  94-821 04 


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Author: 

U.S.  Railroad  Securities 
Commission 

Title: 

Report  of  the  Railroad 
Securities  Commission.. 

Place: 

Washington,  D.C. 

Date: 

1911 


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MASTER    NEGATIVE    • 


COLUMBIA  UNIVERSITY  LIBRARIES 
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U.  S.    Railroad  securities  commission. 

...  Report  of  the  Railroad  securities  commission  to  the 
President,  and  letter  of  the  President  transmitting  the 
report  to  the  Congress  ...    Washington  [Govt,  print,  off.] 

J.«/JLx. 

42  p.    23"".     (62cl  Cong.,  2d  sess.    House.    Doc.  256) 

Dec.  11,  1911.~Message  and  accompanying  papers  ordered  printed  and 
referred  to  the  Committee  on  interstate  and  foreign  commerce. 

Arthur  T.  Hadley,  chairman. 

Pub.  also  in  an  edition  of  44  p.,  without  document  series  note. 

HE2231.U5    1911a 
Copy  2. 

Washington,  Govt,  print,  off.,  1911. 


44p.     23«*: 
J.  Railroads    y.  6.— Finance 
roads  and  state—U.  S. 


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2.  Railroads— Wr-&— Valuation.   3.  Rail- 
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HOUSE  OF  REPRESENTATIVES 


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\    No.  256 


REPORT  OF  THE 


RAILROAD  SECURITIES 

COMMISSION 


TO  THE  PRESIDENT 


AND 


LETTER  OF  THE  PRESIDENT 
TRANSMITTING  THE  REPORT 
TO  THE  CONGRESS     ::     ::     :: 


December  11,  1911.— Message  and  accompanying  papers  ordered  printed 
and  referred  to  the  Committee  on  Interstate  and  Foreign  Commerce 


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LETTER  OF  TRANSMITTAL. 


To  the  Senate  and  House  of  Representatives: 

I  transmit  herewith  for  your  consideration  the  report  which  has 
been  made  to  me  by  the  Railroad  Securities  Commission,  appointed 
under  the  authority  of  section  16  of  the  act  to  create  a  Commerce 
Court,  approved  June  18, 1910  (36  Stat,  556).  The  report  evidences 
for  itself  the  careful  consideration  which  it  has  received  from  the 
commission  and  I  heartily  concur  in  the  recommendations  it  contains 
and  urge  that  appropriate  action  be  taken  to  carry  these  recommenda- 
tions into  effect. 

Wm.  H.  Taft. 
The  White  House,  December  11,  1911, 

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LETTEE  TEANSMITTING  EEPOET  TO 

THE  PEESIDENT. 


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_,     ^  November  1st,  1911. 

The  President: 

We  have  the  honor  to  present  herewith  the  report  of  the  Railroad 
Securities  Commission,  appointed  by  you  in  August  1910  in  ac- 
cordance with  Section  16  of  the  Act  of  Congress  approved  June  18th 
of  that  year,  and  organized  in  the  month  immediately  following. 

Early  in  November,  1910,  a  notice  was  issued  through  the  public 
press  inviting  all  persons  having  information  or  proposals  concern- 
ing the  questions  under  discussion  to  transmit  the  same  to  the  Com- 
mission. Specific  invitations  to  appear  before  the  Commission  or  to 
transmit  opinions  were  also  extended  to  railroad  officials,  members  of 
various  State  Railroad  Commissions,  financiers,  authors  of  books 
and  articles  regarding  railroads,  business  men,  representatives  of 
commercial,  manufacturing  and  shipping  organizations,  bankers, 
lawyers  and  promoters  of  railroads  and  of  their  securities. 

Public  hearings  were  held  as  follows : 

Washington :  November  28,  29,  December  1,  1910. 

New  York:  December  15-22,  1910,  inclusive. 

Chicago:  January  23-27,  1911,  inclusive. 

New  York:  March  6-7,  1911. 

At  these  meetings  thirty-four  witnesses  were  heard.  The  opinions 
of  a  still  larger  number  were  obtained  at  informal  conferences  and  by 
individual  members  of  the  Commission.  Several  hundred  letters 
were  sent  to  other  individuals  or  associations  by  whom  the  subject 
had  been  considered,  and  the  views  received  in  response  to  these  re- 
quests were  transmitted  to  the  members  of  the  Commission  and  duly 
considered  by  them. 

The  accessible  literature  of  the  subject  was  collected  by  the  Secre- 
tary and  examined  by  the  members  of  the  Commission  as  fully  as 
the  circumstances  allowed.  Much  study  was  given  to  the  debates  in 
Congress  leading  up  to  the  passage  of  the  Act  under  which  the  Com- 
mission was  appointed.  A  personal  inquiry  into  foreign  conditions 
was  made  by  the  Chairman  in  October,  1910. 

5 


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6 


REPORT  OF  RAILROAD  SECURITIES  COMMISSION. 


The  Commission  has  not  considered  the  comparative  merits  of 
government  ownership  of  railroads  and  private  ownership  under 
governmental  regulation ;  nor  has  it  attempted  to  enter  into  the  dis- 
cussion regarding  control  of  railroad  rates,  except  as  to  their  relation 
to  the  issue  of  securities.  It  has  adhered  to  the  terms  of  the  Act  of 
Congress  which  confines  the  functions  of  this  Commission  to  the  con- 
sideration of  questions  connected  with  the  issuance  of  stocks  and 
bonds  by  railroad  corporations. 

Respectfully  submitted. 

Arthur  T.  Hadley, 

Chairman. 

William  E.  S.  Griswold, 

Secretary. 


REPOET  OF  OOMMISSIOK 


November  Ist,  1911. 
The  PREsroENT: 

The  imdersigned  have  the  honor  to  make  to  the  President  the  fol- 
lowing report  as  responsive  to  Section  16  of  the  Act  of  Congress  ap- 
proved on  June  18,  1910,  the  material  portion  of  which  reads  as 
follows : 

That  the  President  is  hereby  authorized  to  appoint  a  commission  to  investi- 
gate questions  pertaining  to  the  issuance  of  stocks  and  bonds  by  railroad  cor- 
porations, subject  to  the  provisions  of  the  Act  to  regulate  commerce,  and  the 
power  of  Congress  to  regulate  or  affect  the  same    *     *    *. 

1.   BAILBOAD  SECURITIES  AND  INTERSTATE  COMMERCE. 

The  railroad  companies  of  the  United  States,  with  only  one  im- 
portant exception,  owe  their  present  corporate  existence  to  state 
charters  and  are  subject  to  state  laws  regarding  their  issue  of  stoclis 
and  bonds.  But  a  large  and  growing  proportion  of  their  business  is 
interstate  commerce,  regulated  by  federal  authority.  There  is  a 
widespread  belief  that  the  rates  charged  on  this  business  are  affected 
by  ihe  amount  of  stocks  and  bonds  outstanding;  that  much  stock 
has  been  issued  without  being  fully  paid;  and  that  the  dividends 
on  this  stock  represent  an  unnecessary  tax  on  interstate  commerce. 
The  railroad  men  as  a  rule  deny  that  the  amount  of  capital  of  the 
roads,  either  nominal  or  actual,  is  seriously  considered  by  their 
agents  in  making  rates.  But  it  is  frequently  treated  by  counsel, 
commissions  and  courts  as  a  thing  of  importance  in  determining 
whether  rates  are  reasonable.  If  capitalization  has  an  actual  effect 
on  interstate  rates,  the  federal  government  is  interested,  in  its  ctm- 
trol. 

There  is  still  another  way  in  which  the  issue  of  stock  for  less  than 
par  may  affect  the  conduct  of  interstate  commerce.  The  bond- 
holders who  loan  money  to  the  corporation  may  be  led  to  believe  that 
there  is  a  real  security  behind  the  bonds  equal  to  the  face  value  of 
the  stock,  when  in  fact  a  portion  of  this  value  represents  nothing 
more  substantial  than  the  expectation  of  the  promoters.  So  far  as 
this  deception  affects  only  the  individual  bondholder,  we  may  leave 
it  to  state  law  to  protect  him.  But  if  such  deceptions  become  prev- 
alent they  inevitably  affect  the  confidence  of  investors  as  a  body,  and 


J 


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8 


BEPORT  OF  BAILROAD  SECURITIES  COMMISSION. 


our  American  railroad  systems  fail  to  get  the  full  amount  of  capital 
needed  for  their  development  and  for  the  proper  conduct  of  their 
yiterstate  business.  It  is  a  matter  of  direct  concern  to  the  federal 
government  that  the  facilities  for  handling  commerce  between  the 
states  should  not  be  impaired. 

These  facilities  embrace  not  only  steam  railroads,  but  the  other 
agencies  of  communication  and  transportation  enumerated  in  the 
Act  to  Kegulate  Commerce.  While  for  brevity  the  language  of  this 
report  is  largely  confined  to  railroads,  the  discussion  and  recom- 
mendations apply  generally  to  these  other  agencies. 

2.  PRESENT  REQUIREMENTS  AND  FUTURE  POLICY. 

Starting  from  different  points,  investors  and  shippers,  and  through 
them  the  general  public,  have  come  to  feel  that  state  legislation  has 
provided  inadequate  security  for  their  interests  in  this  matter.  The 
question  is  therefore  asked  with  increasing  frequency  whether  the 
United  States  Government  should  not  undertake  to  regulate  the 
issues  of  securities  by  the  roads  engaged  in  interstate  commerce  as  a 
necessary  means  to  its  effective  control.  This  question  naturally 
divides  itself  into  two  parts :  First,  what  immediate  action  by  Con- 
gress will  best  meet  the  existing  situation ;  and  second,  what  general 
principles  should  guide  the  federal  government  in  its  future  legisla- 
tion on  this  subject. 

As  far  as  concerns  the  immediate  action  of  Congress,  we  believe 
that  stringent  provisions  regarding  publicity  of  stock  and  bond 
issues,  which  will  show  how  far  the  laws  are  obeyed,  and  will  enable 
the  federal  government  to  hold  the  railroad  officials  responsible  for 
the  consequences  of  not  obeying  them,  will  be  more  salutary  and 
more  effective  than  any  new  statutory  demands.  So  long  as  the  rail- 
ways engaged  in  interstate  commerce  are  chartered  by  the  states  and 
subject  to  state  laws  regarding  their  securities,  added  federal  re- 
striction will  tend  to  create  further  confusion  in  a  situation  already 
too  complex. 

But  we  also  believe  that  the  time  is  near  when  the  difficulties  of 
the  present' system  of  dual  control,  and  the  conflict  of  state  laws,  will 
become  so  manifest  that  further  legislation  on  the  subject  will  be  im- 
perative. Unless  the  constitutional  power  of  Congress  to  regulate 
the  securities  of  railroads  engaged  in  interstate  commerce  is  defi- 
nitely established  as  being,  to  the  extent  that  Congress  acts  upon  the 
subject,  exclusive  of  State  control,  one  of  two  things  seems  likely  to 
happen :  Either  the  federal  government  and  the  governments  of  the 
several  states  will  come  to  a  common  understanding  as  to  the  prin- 
ciples to  be  adopted  in  the  control  of  security  issues,  or  the  railroad 
systems  will  be  given  the  opportunity  to  exchange  their  State  Char- 
ters for  Federal  ones.    We  have  therefore  discussed  in  some  detail 


REPORT  OF  RAILROAD  SECURITIES   COMMISSION. 


9 


the  principles  which  ought  to  govern  the  stock  and  bond  issues  of 
railroads  in  the  United  States.  Whichever  alternative  we  adopt,  \^  e 
ought  to  have  such  a  set  of  principles  before  us.  If  we  are  to  bring 
about  a  common  understanding,  we  need  them  as  a  basis  of  negotia- 
tion. If  we  consider  federal  incorporation  of  railroads  the  more  de- 
sirable or  practicable  alternative,  we  need  them  as  the  groundwork 
of  a  federal  incorporation  law,  of  which  our  roads  may  avail  them- 
selves when  their  interests  and  those  of  the  public  require  it.  Under 
the  terms  of  the  Act  of  Congress  creating  this  Commission,  it  has  not 
considered,  as  an  alternative  to  these  possibilities,  the  direct  owner- 
ship of  the  railroads  by  the  government  itself.  In  that  case  the 
government  would  issue  its  own  securities,  and  none  of  the  questions 
submitted  to  this  Commission  would  then  arise. 

3.   THEORY  OF  RAILROAD  STOCK  ISSUES. 

Everyone  knows  that  railroad  securities  are  divided  into  two 
classes,  stoclcs  and  bonds;  very  few  people  apprehend  as  plainly  as 
they  should  the  distinction  between  the  two,  or  understand  the  real 
nature  of  a  share  of  railroad  stock.  As  to  the  real  nature  of  a  rail- 
road bond,  there  is  no  doubt  at  all.  It  is  essentially  a  note  made  by 
the  company;  a  promise  to  pay  a  certain  amount  of  money,  say  one 
thousand  dollars,  at  a  specific  date  of  maturity,  and  to  pay  interest 
at  specified  rates  in  the  meantime.  The  obligation  is  definite.  The 
value  is  limited  by  the  terms  of  the  instrument. 

But  a  share  of  railroad  stock  is  of  a  different,  and  more  complex, 
character.  It  represents  two  things  instead  of  one:  That  a  certain 
sum  has  been  paid  in,  and  that  the  holder  of  the  stock  has  a  certain 
share  in  the  ownership  of  the  property,  of  whatever  value  that  may 
prove  to  be.  The  second  of  these  things  is  what  ultimately  gives  the 
stock  certificate  its  value.  In  the  case  of  a  railroad  bond  the  fact 
that  it  calls  for  one  hundred  or  one  thousand  dollars  is  a  determin- 
ing factor  in  what  it  is  worth.  But  in  the  case  of  stock,  the  fact  that 
the  certificate  represents  one  hundred  or  one  thousand  dollars  is  far 
from  being  the  determining  factor.  It  is  but  one  incident  among 
many.  Even  in  theory  it  purports  merely  to  show  that  this  was  the 
amount  originally  paid  by  the  subscriber  when  the  road  was  built. 
It  does  not  create  an  obligation  to  pay  its  face  value,  nor  does  that 
face  represent  its  money  value  as  a  share.  The  value  varies  with  the 
development  of  the  property  as  a  whole.  If  it  has  been  wisely 
located  and  well  managed  it  will  be  worth  more  than  the  amount  it 
represents.  If  it  has  been  unwisely  located,  or  badly  managed,  it 
will  be  worth  less  than  the  amount  it  represents.  The  shareholder 
chose  his  investment,  elected  his  management  and  took  his  risl«.  If 
he  acted  unwisely  and  fares  badly  he  has  no  claim  that  the  public 
should  indemnify  him.    If  he  did  well,  the  public  can  not  either 


J 


10 


REPORT  OF  RAILROAD  SECURITIES  COMMISSION. 


M 


rightly  or  wisely  fail  to  recognize  and  reward  his  foresight,  so  long 
as  his  road  is  managed  with  proper  regard  to  the  interest  of  the  com- 
munity, and  for  the  development  of  the  traffic  which  it  carries. 

The  principal  of  a  bond  is  a  fixed  sum,  its  interest  a  fixed  charge. 
The  value  of  a  share  of  stock  is  essentially  variable,  its  profit  essen- 
tially indeterminate. 

There  is  a  persistent  tendency  to  ignore  this  distinction;  to  em- 
phasize unduly  the  face  value  of  the  stock;  to  treat  the  shares  in  a 
railroad  or  other  public  service  corporation  as  claims  against  the 
community  for  the  number  of  dollars  they  represent,  rather  than  as 
fractional  interests  in  a  more  or  less  hazardous  enterprise,  in  which 
the  investors  took  risks  of  loss  and  chances  of  profit ;  to  allow  cor- 
porations to  claim  immunity  from  public  regulation  when  the  divi- 
dend on  the  face  value  of  the  shares  is  below  the  prevailing  rate  of 
interest ;  and  to  subject  them  to  vexatious  attacks  when  this  dividend 
is  above  the  prevailing  rate  of  interest,  even  when  such  profit  may  be 
a  fair  compensation  for  risks  actually  incurred  in  the  past  or  a  neces- 
sary incentive  for  the  investment  of  new  capital  and  the  taking  of 
new  risks  in  the  future. 

4.   STATE  LEGISLATION  REGARDING  STOCK  ISSUES. 

Nowhere  has  this  tendency  been  more  marked  than  in  the  legisla- 
tion of  the  several  states  regarding  stock  issues  of  railroad  corpora- 
tions. It  has  led  our  law  makers  to  lay  too  much  stress  on  keeping 
down  the  nominal  amount  of  stock,  and  too  little  upon  getting  the 
actual  amount  of  capital  needed  and  having  it  properly  used. 

Nearly  all  the  states  require  that  railroad  stock  issues  should  be 
paid  in  full  at  their  face  or  par  value.  Eighteen  have  this  provision 
in  their  constitutions ;  a  majority  of  the  others  have  more  or  less  defi- 
nite laws  to  the  same  effect.  Even  without  such  specific  statute  the 
requirement  that  the  shareholder  may  be  called  upon  to  meet  the  full 
value  of  his  stock  subscription  is  operative  in  the  absence  of  legisla- 
tion to  the  contrary.  Of  such  legislation  there  has  been  relatively 
little.  West  Virginia  alone,  among  all  the  states,  expressly  sanctions 
the  issuance  of  stock  at  less  than  par,  although  there  are  several 
others  where  exceptions  to  the  rule  of  full  payment  have  been 
allowed,  either  by  general  statute  or  by  special  act  of  the  legislature 
in  particular  cases. 

5.  EVASION  OF  STATE  LAWS. 

Where  the  strictness  of  the  law  regarding  capital  stock  has  inter- 
fered with  the  building  of  railroads  in  new  communities,  evasion  of 
its  letter  or  spirit  by  railroad  companies  have  been  frequent.  The 
very  rigidity  of  the  statute  has  caused  the  public  to  be  negligent  in 
its  enforcement.     In  some  cases  the  laws  have  been  so  drawn  as  actu- 


REPORT  OF  RAILROAD  SECURITIES  COMMISSION. 


11 


ally  to  invite  evasion,  by  specifically  leaving  it  to  the  judgment  of  the 
directors  to  decide  what  constituted  an  adequate  consideration  for 
the  shares.  The  companies  have  thus  been  enabled  to  represent  that 
their  stock  was  fully  paid,  when  this  was  not  in  fact  the  case.  Some- 
times stock  has  been  issued  by  the  promoters  of  a  company  to  them- 
selves as  a  reward  for  their  services  in  organization  and  management. 
Sometimes  it  has  been  issued  in  exchange  for  rights  of  way  and  other 
forms  of  assistance  to  the  construction  of  a  new  road,  without  much 
regard  to  the  cash  value  of  the  consideration  received.  Sometimes  it 
it  has  been  issued  to  stockholders  to  represent  the  increased  value  of 
their  property,  actual  or  prospective,  on  the  theory  that  such  value 
represents  undivided  profits  which  the  stockholders  have  not  received 
or  do  not  receive  in  cash,  and  are  therefore  entitled  to  obtain  in  scrip. 
Sometimes  it  has  been  issued  in  reorganizations,  consolidations,  or  in 
exchange  for  the  stock  of  other  companies,  on  terms  not  really  war- 
ranted bv  the  facts  in  the  case.  Sometimes  stock  so  issued  as  full 
paid  has  been  given  as  a  bonus  to  induce  people  to  subscribe  for 
bonds. 

Besides  these  direct  methods  of  evasion,  there  have  been  more 
indirect  means  of  reaching  the  same  result.  Lines  have  been  built 
through  the  agency  of  construction  companies  and  paid  for  by  the 
issue  of  securities  whose  face  value  considerablv  exceeded  the  actual 
cost  of  the  roads  themselves. 

All  these  practices,  with  the  possible  exception  of  the  one  last  named, 
have  been  much  more  frequent  in  the  past — particularly  during  the 
great  periods  of  railroad  expansion  from  1853-57,  1869-72, 1879-82 — 
thtfti  they  have  been  in  recent  years.  This  change  is  not  wholly  due 
to  increased  stringency  in  the  laws.  It  is  partly  due  to  wise  admin- 
istrative measures  for  their  enforcement,  and  partly  to  the  increased 
demands  of  investors  in  bonds  for  the  real  data  as  to  the  security 
underlying  them,  which  has  compelled  managers  of  corporations  to 
give  greater  publicity  as  to  the  real  facts.  The  Chicago  &  Alton 
reorganization  is  the  only  instance  in  the  last  decade  which  has  been 
brought  to  our  cognizance  where  the  public  has  been  offered  a 
large  issue  of  railroad  stock  (as  distinct  from  the  stock  of  a  holding 
company),  based  merely  upon  an  estimated  increase  of  value.  Re- 
cent attempts  to  capitalize  expected  profits  in  connection  with  other 
public  service  corporations  or  with  industrials,  do  not  come  within 
the  scope  of  this  inquiry. 

6.   DANGER  OF  EVASION  OF  FEDERAL  LAW. 

A  federal  law  requiring  full  payment  of  all  stock  issues,  without 
special  machinery  to  enforce  it,  could  be  evaded  as  state  laws  have 
been  evaded  in  the  past.     In  fact,  the  liability  to  evasion  might  be 


li 


BEPORT  OF  RAILROAD  SECURITIES  COMMISSION. 


greater,  because  in  some  parts  of  the  country  a  statutory  require- 
ment of  this  kind,  imposed  by  the  federal  government,  would  be 
regarded  as  an  interference  with  the  rights  of  the  several  states; 
and  local  companies  attempting  to  build  new  lines  with  stock  not 
fully  paid  might  have  the  support  of  local  public  sentiment  in  so 
doing.  It  is  possible  that  in  some  instances  the  federal  government 
could  not  even  count  upon  the  vigorous  assistance  of  the  state 
authorities  themselves  in  trying  to  enforce  such  an  Act  at  all  rigidly. 
Such  a  federal  requirement  superadded  to  the  state  requirement 
miglit  simply  mean  that  every  company  would  be  led  to  make  two 
deceptive  returns  instead  of  one.  A  federal  requirement  conflicting 
with  a  state  requirement  might  leave  us  in  an  even  worse  case;  for 
the  impossibility  of  obeying  both  authorities  would  be  made  an 
excuse  for  obeying  neither.  This  would  clearly  be  true  until  the 
paramount  authority  of  the  federal  government  was  established. 

7.  ENFORCED  UNIFORMITY  NOT  YET  ATTAINABLE. 

To  make  legislation  of  this  kind  effective,  it  would  be  necessary 
to  provide  federal  agencies  for  carrying  out  its  requirements  in 
detail.  We  should  be  compelled  either  to  burden  the  Interstate 
Coinuierce  Commission  with  a  large  amount  of  additional  work,  or 
to  create  a  new  commission  to  supervise  railroad  incorporation  and 
construction  in  different  parts  of  the  country. 

If  we  were  ready  to  substitute  exclusive  federal  control  for  the 
jurisdiction  of  the  several  states  over  their  railroad  corporations, 
much  could  be  said  in  behalf  of  the  establishment  of  a  national 
authority  to  supervise  both  the  issuance  of  stocks  and  bonds  and  the 
actual  expenditure  of  their  proceeds.  But,  apart  from  the  consti- 
tutional difficulties  which  might  stand  in  the  way  of  such  a  pro- 
cedure, your  Commission  is  of  opinion  that,  as  a  mere  matter  of 
expediency,  the  time  is  not  ripe  for  any  such  immediate  or  forcible 
transfer  of  jurisdiction.  The  local  needs  of  different  parts  of  the 
country  are  still  divergent.  Many  railroad  problems,  both  of  oper- 
ation and  of  control,  are  still  in  the  experimental  stage.  Enforced 
uniformity  under  federal  law  would,  in  the  opinion  of  many,  dis- 
criminate against  the  development  of  new  territory,  and  the  forma- 
tion of  independent  companies;  for  a  well  established  system  has 
less  difficulty  in  securing  the  necessary  capital  by  pledging  its  credit 
than  an  independent  projector  wishing  to  develop  a  new  district. 
These  dangers  and  difficulties  may  have  been  somewhat  exaggerated. 
While  they  undoubtedly  exist  in  certain  cases,  they  are  of  a  sporadic, 
rather  than  a  general,  character.  But  they  are  urged  with  much 
force,  both  by  state  railroad  commissioners  and  by  independent 
builders;  and  they  would  constitute  obstacles  to  the  effective  en- 
forcement of  a  federal  statute.    Before  such  a  statute  is  enacted, 


REPORT  OF  RAILROAD  SECURITIES  COMMISSION. 


13 


it  should  be  clearer  than  it  now  is  that  public  opinion  would  support 
it.  Under  such  circumstances  the  immediate  assertion  of  exclusive 
federal  jurisdiction  under  one  general  railroad  law  appears  unwise. 
Until  such  exclusive  jurisdiction  can  be  established,  the  creation 
of  a  separate  administrative  body  subjecting  the  railroads  of  the 
country  to  a  new  system  of  concurrent  supervision,  in  addition  to 
the  many  old  ones  which  now  exist,  does  not  seem  just,  expedient 
or  economical. 

8.  ENFORCED  PUBLICITY  IMMEDIATELY  NEEDED. 

In  place  of  any  added  federal  requirements  concerning  payment 
for  capital  stock,  your  Commission  recommends  the  adoption  of 
provisions  regarding  publicity  which  will  show  the  actual  facts 
regarding  stock  and  bond  issues  in  the  several  states,  and  the  con- 
sideration received  therefor.  Any  railroad  doing  interstate  busi- 
ness which  issues  bonds  or  stocl«  should  be  required  by  statute  to 
furnish  the  Interstate  Commerce  Commission,  at  the  time  of  the 
issue,  with  a  full  statement  of  the  details  of  the  issue,  the  amount 
of  the  proceeds,  and  the  purposes  for  which  the  proceeds  are  to  be 
used,  followed  in  due  time  by  an  accounting  for  such  proceeds,  as 
more  fully  hereinafter  set  forth. 

An  Act  of  this  kind  does  not  limit  the  freedom  of  the  several  states 
to  make  any  kind  of  laws  which  they  please  regarding  their  own 
corporations.  If  they  want  them  stringent  they  may  make  them 
stringent.  If  they  think  they  can  encourage  the  investment  of  capi- 
tal by  .permitting  the  issue  of  stock  for  less  than  par,  they  can  allow 
such  issues.  If  the  result  of  enforcing  existing  laws  interferes  with 
local  needs,  they  may  change  the  laws.  But  the  companies  must 
indicate  precisely  what  they  are  doing.  They  must  not  attract  the 
bondholders'  money  by  representing  that  there  has  been  a  payment 
of  one  hundred  cents,  when  there  has  been  a  payment  of  only  fifty 
cents.  They  may,  if  they  please,  direct  the  treasurer  to  set  down 
their  partly  paid  stock  in  the  balance  sheet  as  a  liability  in  full ;  but 
they  must  make  it  plain  to  the  investor  today  and  to  the  public  to- 
morrow how  much  of  that  liability  was  represented  by  cash  assets 
contributed  and  how  much  consisted  of  what  is  called  in  English 
balance  sheets  "nominal  additions  to  capital."  Such  liability  is  of 
the  corporation  to  its  stockholders  and  not  of  the  public  to  either. 

9.  MODE  OF  PROCEDURE. 

Two  courses  lie  open  before  us  in  our  effort  to  secure  publicity 
regarding  railroad  securities:  Either  to  require  the  express  sanction 
of  some  administrative  body  (presumably  the  Interstate  Commerce 
Commission)  before  such  securities  are  issued,  or  to  rely  on  general 
statutory   provisions   under   which   the   directors   may   issue   such 


14 


REPORT  OF  BAILBOAO  SECURITIES  COMMISSION. 


i5 


securities  and  be  held  responsible  for  their  proper  use.  In  the  case  of 
either  of  these  alternatives,  the  accounting  required  must  be  full  and 
adequate  in  every  respect,  and  the  Interstate  Commerce  Commission 
or  other  administrative  authority  must  be  empowered  to  do  whatever 
may  be  necessary  in  its  judgment  to  secure  compliance  with  the 
statute  and  to  prevent  injury  to  the  public.  Either  alternative  would 
mvolve  the  valuation  of  property  and  services  whenever  such  valua- 
tion may  become  necessary  in  establishing  the  integrity  of  the  finan- 
cial transactions  involved.  , 

The  first  alternative  insures  reasonably  full  publicity  before  the 
fact.  Official  inquiry  following  the  formal  application  would  twid 
to  discourage  attempts  at  evasion;  and  would  probably  in  many  in- 
stances prevent  the  filing  of  applications  for  issues  which  are  ques- 
tionable either  because  of  their  financial  unsoundness  or  because  thev 

• 

duplicate  existing  lines  instead  of  adding  to  public  convenience. 

Your  Commission  nevertheless  prefers  the  second  alternative  and 
doubts  the  expediency  under  present  conditions  of  a  general  law 
forbidding  railroads  to  sell  securities  without  specific  authorization 
in  advance,  it  being  understood  that  the  face  value  of  these  securities 
is  not  to  be  construed  as  an  obligation  on  the  public.  Authorization 
in  advance  would  tend  to  create  an  impression  on  the  part  of  the 
investing  public  of  a  guaranty  or  official  recognition  of  values,  which 
no  administrative  authority  can  safely  give.  The  absence  of  such 
recommendation  by  this  Commission  is  intended  to  make  it  clear  that 
no  such  guaranty  should  be  given.  A  growing  railroad  has  con- 
stant need  of  money,  and  its  officers  and  directors  are  the  best 
judges  of  the  amount  of  its  annual  i*equirements.  It  is  manifestly  to 
the  interest  of  the  company  and  of  the  public  that  a  road  should  get 
its  money  as  cheaply  as  it  can.  The  policy  of  allowing  a  floating 
debt  to  accumulate  with  a  view  to  its  extinction  by  the  sale  of  per- 
manent securities  upon  the  completion  of  its  improvements  is  not  jbl 
good  one,  and  should  be  avoided  wherever  possible.  An  adminis- 
trative body  whose  approval  was  required  in  advance  for  the  sale  of 
securities  would  have  great  difficulty  in  always  acting  promptly 
enough  to  enable  the  roads  to  avail  themselves  of  favorable  money 
markets,  and  avoid  the  creation  of  floating  debt,  and  might  do  its 
work  so  carelessly  as  to  result  in  shielding  the  directors  from 
responsibility,  instead  of  acting  as  i.  safeguard  to  the  public. 

We  are  disposed  to  leave  for  the  present  to  state  commissions  the 
responsibility  of  passing  upon  the  questions  of  public  convenience 
and  necessity  involved  in  the  building  of  lines  to  be  constructed 
within  the  limits  of  their  several  states,  and  to  rely  on  full  publicity 
as  to  the  use  of  the  proceeds  of  the  sale  of  securities  and  of  other 
assets  as  a  safeguard  against  financial  abuses. 


REPORT  OF  RAILROAD   SECURITIES   COMMISSION. 


10.   FACTS  TO  BE  DISCLOSED. 


15 


With  this  end  in  view,  every  company  should  be  required  to  fur- 
nish to  the  Interstate  Commerce  Commission  at  specified  dates  a  full 
statement,  including  the  names  of  the  parties  concerned,  of  all  finan- 
cial transactions  that  have  taken  place  during  the  periods  covered  by 
the  report,  whether  in  cash,  in  securities,  or  in  other  valuable  con- 
siderations, and  whether  embraced  in  income  account  or  outside  of  it. 
This  statement  should  also  include  the  disposition  of  surplus.  Every 
company  should  be  further  required  to  compile  for  the  information 
of  its  shareholders  facts  in  regard  to  the  financial  transactions  of 
the  company  for  its  fiscal  year,  of  such  a  character  and  in  such  form 
as  the  Interstate  Commerce  Commission  may  direct. 

The  Interstate  Commerce  Commission  should  have  the  power  to 
investigate  all  such  financial  transactions  and  to  inquire  into  the 
bona  fides  thereof ;  the  right  to  call  for  the  production  of  books  and 
papers  of  railroad  companies,  construction  companies  or  other  com- 
panies with  which  the  railroad  company  shall  have  had  financial 
transactions,  for  the  purpose  of  enabling  it  to  verify  any  state- 
ments so  furnished  to  it;  and  the  power  to  examine  into  the  actual 
cost  as  well  as  the  value  of  property  acquired  or  of  services  ren- 
dered. In  all  transactions  investigated,  from  the  purchase  of  sup- 
plies to  the  acquirement  of  new  lines  by  consolidation,  every  interest 
of  the  directors  should  be  disclosed,  and  adequate  penalties  provided 
for  any  failure  to  make  such  disclosure. 

This  enumeration  is  illustrative  and  not  inclusive.  Some  of  these 
items  the  Interstate  Commerce  Commission  now  requires  in  the 
reports  of  the  companies;  other  items  are  not  now  required  and 
probably  cannot  be  under  the  present  Act  to  Regulate  Commerce. 
All  of  them  call  for  facts  or  groups  of  facts  which  the  Interstate 
Commerce  Commission  should  be  empowered  to  ascertain  in  the 
administration  of  an  amendment  to  the  Act  to  Regulate  Commerce, 
concerning  which  we  have  prepared  and  attach  to  this  report  a 
more  definite  suggestion. 

11.   PHYSICAL  VALUATION. 

"  Physical  valuation  "  of  railroads  in  its  bearing  on  capitalization 
has  been  to  some  extent  advocated,  and  to  a  greater  extent  opposed, 
upon  the  idea  that,  if  undertaken  by  the  United  States  Gover^iment, 
it  will  be  made  a  justification  for  reducing  the  amount  of  the  out- 
standing securities  of  the  railroads  to  the  figure  thus  ascertained, 
or  for  preventing  them  from  issuing  new  securities  when  the  amount 
of  their  outstanding  stocks  and  bonds  exceeds  the  physical  value  of 
their  properties  as  so  determined.  Should  a  valuation  of  the  physical 
property  of  railroads  be  made,  it  ought  not,  if  properly  applied,  to 
involve  either  of  those  dangers. 


16 


REPORT  OF  RAILROAD  SECURITIES  COMMISSION. 


An  attempt  to  scale  down  old  securities  is  clearly  out  of  the  ques- 
tion. Apart  from  the  obvious  constitutional  diflSculties  of  such  a 
course,  considerations  of  public  expediency  of  themselves  forbid  it. 
The  direct  loss  from  the  unsettlement  of  legal  and  equitable  rela- 
tions would  be  very  great.  The  indirect  loss  from  the  withdrawal 
of  confidence  in  American  railroad  investments  would  be  immeasur- 
able. Such  a  readjustment. would  become  archaic  almost  from  the 
outset,  because  an  adjustment  of  securities  based  upon  the  values  of 
today  might  be  totally  erroneous  tomorrow.  It  would  be  equally 
inadvisable,  in  cases  where  outstanding  securities  were  in  excess  of 
the  physical  valuation,  to  prohibit  the  issue  of  new  securities  until 
physical  value  had  become  equal  to  the  amount  of  securities  out- 
standing; because  this  principle,  if  generally  applied,  would  prevent 
roads  so  situated  from  securing  the  capital  needed  for  the  service 
of  the  community. 

Whenever  a  railroad  company  acquires  new  property  in  return 
for  the  issue  of  its  securities,  or  in  expending  the  proceeds  of  such 
securities,  every  means  should  be  placed  at  the  disposal  of  the  Inter- 
state Commerce  Commission  to  ascertain  the  value  of  such  property 
as  accurately  as  possible.  A  fundamental,  though  not  necessarily 
a  controlling,  element  in  value,  is  cost  of  reproduction.  This  is 
true  of  property  in  general ;  it  has  been  specifically  affirmed  of 
railroad  property  by  the  Supreme  Court  of  the  United  States.  Emi- 
nent railroad  men  who  have  appeared  before  this  Commission  have 
stated  that  in  their  opinion  cost  of  reproduction  or  physical  value 
was  the  most  important  single  element  in  determining  the  true  value 
of  the  railroad  as  a  whole.  Indeed,  we  believe  it  to  be  in  the  interest 
of  railroads,  no  less  than  of  those  who  use  them,  that  the  Interstate 
Commerce  Commission  should  be  given  broad  powers  and  adequate 
means  for  valuation  of  the  physical  property  of  railroads  as  one 
element  in  determining  fair  value,  whenever,  in  the  judgment  of 
that  Commission,  this  is  of  sufficient  importance  to  warrant  such 
action.  This  will  give  the  public  information  which  it  is  entitled 
to  demand,  and  which  can,  in  our  judgment,  be  letter  and  more  eco- 
nomically obtained  in  this  way  than  in  any  other.  The  attempt  to 
oppose  a  system  of  physical  valuation  of  this  kind  tends  to  give 
countenance  to  exaggerated  estimates  of  the  amount  of  water  in  rail- 
road stocks. 

12.  RESULTS  TO  BE  EXPECTED. 

We  believe  that  the  powers  granted  to  the  Interstate  Commerce 
Commission  by  the  preceding  recommendations  may  be  found  large 
enough  to  protect  the  public,  without  the  necessity  of  passing  a  law 
that  should  require  specific  approval  in  advance  of  the  amount  and 
purpose  of  stock  and  bond  issues. 


SEPOKT  01'  RAILROAD   SECUKITJES   COMMiSSiOX. 


17 


We  do  not  say  that  the  enforcement  of  a  law  of  this  kind  will  be 
easy.  The  public  in  all  parts  of  the  country  has  become  accustomed 
to  the  evasion  of  laws  concerning  capital  stock.  It  is  far  easier  to 
pww  a  radical  measure  which  is  going  to  be  evaded  than  to  secure 
obedience  to  a  conservative  one.  But  we  are  confident  that  full 
public  knowledge  of  the  facts  will  diminish  the  evils  and  misunder- 
standings  described  in  the  opening  paragraphs  of  this  report  as  being 
the  chief  .sources  of  the  demand  for  immediate  federal  action,  and 
will  at  the  same  time  furnish  the  proper  foundation  on  which  to'  base 
more  thorough -going  reforms. 

One  of  these  evils  was  that  bondholders  were  at  times  deluded  into 
the  belief  that  there  was  a  security  behind  their  bonds  which  did  not 
exist,  and  that  the  railroad  company  was  mortgaging  a  piece  of 
property  when  it  was  only  capitalizing  an  expectation.    They  thus 
entrusted  the  control  of  their  money  to  men  who  had  comparatively 
little  at  stake.     If  a  profit  was  made,  the  promoters  could  appro- 
priate It;  if  money  was  lost,  the  loss  fell  on  the  bondholders.    Roads 
built  largely  with  borrowed  capital  at  the  beginning  have  been  pre- 
vented   from  subsequently  obtaining  the  credit  which  they  mi<-ht 
otherwise  command.    They  have  therefore  been  less  abl^  to  give'' to 
the  shippers  or  to  the  travelers  the  facilities  which  are  requisite  no 
less  for  the  convenience  and  safety  of  the  public,  than  for  the  profit- 
able utilization  of  the  railroad  itself.    To  the  extent  that  we  lessen 
debt,  we  shall  increase  the  power  of  the  roads  to  raise  money  when 
the  public  needs  added  facilities  and  shall  at  the  same  time  reduce 
the  chance  of  default  and  lessen  the  severity  of  commercial  crises. 
But  to  most  people  the  danger  of  these  financial  consequences 
seems  a  less  serious  thing  than  the  danger  that  the  railroads  wiU  tax 
the  users  of  the  road  for  the  sake  of  making  profits  on  capital  not 
actually  furnished.    The  necessity  for  paying  interest  on  bonds,  and 
the  desirability  of  providing  for  dividends  on  stock  are  sometimes 
urged  as  a  justification  for  increased  rates;  and  they  are  frequently 
put  forward  as  a  reason  why  existing  rates  may  not  fairly  be  inter- 
fered with  by  law.    To  meet  this  danger,  so  far  as  it  is  a  real  one, 
and  to  avoid  this  misapprehension  so  far  as  it  is  a  misapprehension^ 
it  is  essential  that  the  stock  should  be  what  it  purports  to  be.    If  it 
purports  to  represent  one  hundred  dollars  paid  in  on  every  share,  one 
hundred  dollars  should  actually  be  paid  in.    If  it  purports  only  to  be 
a  participation  certificate,  giving  a  proportionate  interest  in  ony 
profits  that  may  be  earned,  it  must  be  understood  that  this  is  its 
e&sential  character,  and  that  if  it  claims  any  further  rights  than  this, 
it  must  prove  them  by  specific  evidence.    This  is  in  the  interest  of  all 
parties— of  the  honest  investor  and  the  progressive  manager,  of  the 
shipper,  the  traveler  and  the  general  public. 

H.  Doc.  2.56,  62-2 2 


I. 


i.*rJ9^.*^-r  •^.Tj-% 


13 


REPORT  OF   RAILROAD   SECURITIES   COMMISSION. 


If  full  publicity  be  given  to  the  facts,  we  shall  als^o  lessen  the 
fraudulent  creation  of  debt.  It  is  the  degree  of  publicity  as  to  the 
facts,  rather  than  the  stringency  of  the  law,  which  gives  the  people 
any  real  protection.  A  stringent  law  inadequately  enforced  and 
secretly  evaded  is  the  worst  thing  that  can  possibly  be  offered  the 
public,  because  it  gives  color  to  claims  which  have  no  foundation  in 
fact. 

13.   CONFLICTS    OF    JURISDICTION. 

\ATiile  we  do  not  think  that  the  time  is  ripe  for  a  sudden  and  quasi- 
compulsory  transfer  of  the  direct  control  of  the  stock  and  bond  issues 
of  interstate  railroads  from  the  states  to  the  federal  government,  we 
cannot  help  recognizing  that  there  are  conflicts  of  jurisdiction  in  the 
construction,  operation  and  financing  of  interstate  railroads  which 
mav  more  and  more  embarrass  interstate  commerce  and  necessitate  a 
larger  degree  of  federal  control,  or  even  result  in  federal  incorpora- 
tion. 

A  road  organized  by  an  individual  state  is  subject  to  state  jurisdic- 
tion regarding  certain  rates  and  facilities  and  purposes  for  which 
securities  may  be  issued,  and  is  responsible  to  the  state  courts  for  the 
performance  of  its  functions.  The  instant  that  its  cars  pass  across 
the  state  line  or  that  its  shipments  are  routed  to  points  in  other  states 
it  becomes  responsible  to  the  Interstate  Commerce  Commission  and 
to  the  federal  courts.  Constitutionally  Congress  has  paramount  au- 
thority over  interstate  commerce  and  by  its  action  can  abrogate  any 
previous  action  of  the  states  which  may  prove  inconsistent  therewith. 
Practically  it  is  easy  to  see  how  a  conflict  may  arise  between  local  and 
national  requirements  regarding  facilities  or  methods.  The  state 
may  prescribe  one  way  of  doing  business;  the  national  government 
may  prescribe  another,  and  forbid  the  one  ordered  by  the  state.  It 
is  only  by  the  care  of  our  railroad  commissioners,  state  and  national, 
that  serious  difficulties  of  this  kind  have  been  avoided  in  the  past. 

Even  more  perplexing  are  the  questions  which  may  arise  in  con- 
nection with  tiie  control  of  interstate  railroad  rates.  The  local  leg- 
islatures and  commissions  have  ideas  of  their  own  regardmg  rates 
which  may  differ  in  some  respects  from  the  ideas  of  Congiess  or  of 
the  Interstate  Commerce  Commission.  But  the  relation  between 
through  and  local  rates  is  fi*equently  so  close  that  the  two  sets  of 
things  cannot  be  arranged  on  independent  principles.  The  reason- 
ableness of  the  through  rate  may  depend  upon  its  relation  to  the  local 
rate,  and  vice  versa.  It  becomes  increasingly  difficult  each  year  to 
leave  a  corporation  free  to  fix  its  local  rates  subject  to  the  jurisdiction 
of  state  commissions  and  state  courts  only. 

Thus  the  exercise  by  a  state  of  its  authority  over  railroads  or- 
ganized or  operating  in  its  territory,  prescribing  terms  on  which, 


A^ 


REPOHT   OF   KAILROAD   SECURITIES   COMMISSIUN. 


19 


and  the  limitations  within  which,  it  may  issue  securities,  may  di- 
rectly interfere  with  and  embarrass  interstate  commerce,  when  the 
issue  of  such  securities  is  essential  for  raising  funds  to  be  applied 
in  furnishing  the  necessary  facilities  for  its  interstate  traffic.  One 
or  more  instances  of  this  have  been  brought  to  our  attention.  That 
they  have  not  been  more  numerous  is  doubtless  owing  to  the  discre- 
tion and  conservatism  which  have  usually  characterized  the  action 
of  state  commissions.  Such  state  regulation  of  the  security  issues 
of  interstate  railroads  may  be  wise  or  unwise  from  a  local  point  of 
view;  but  the  state  determination  cannot  control  the  federal  right. 
This  danger  of  possible  interference  with  interstate  commerce  nec- 
essarily tends  to  increase  with  the  number  and  activity  of  state  com- 
missions; and  it  was  for  the  protection  of  such  commerce  against 
any  interference  that  the  power  of  regulation  was  vested  in  the  fed- 
eral government 

14.   DEVELOPMENT  BY  INTERCORPOBATE  HOLDING. 

Some  states  have  laws  compelling  railroads  within  their  borders 
to  be  organized  under  the  laws  of  the  states  in  which  they  are  located 
and  forbidding  foreign  corporations,  so-called,  from  cqnstructing, 
owning  and  operating  lines  thus  located.  The  effect  of  these  and 
other  similar  statutes  have  been  largely  avoided  by  a  system  of  inter- 
corporate holdings,  under  which  a  corporation  organized  in  one 
state  which  owns  the  stock  or  the  major  part  of  the  stock  of  a  road  in 
another  state  can  secure  the  capital  necessary  for  construction  or 
betterment  without  subjecting  itself  to  the  restrictive  laws  of  the 
state-where  the  money  is  actually  spent.  One  or  two  instances  will 
show  how  this  system  works. 

'  The  state  of  Texas  has  a  law  which  rigidly  limits  the  extent  to 
which  roads  in  that  state  may  be  capitalized.  It  seems  to  have  been 
the  expectation  of  those  who  passed  the  Texas  law  that  it  would 
be  a  protection  to  all  those  interested  in  the  proper  operation  and 
regulation  of  railroads.  But  it  has  had  the  practical  effect  of  mak- 
ing it  difficult  to  get  directly  by  the  sale  of  securities  of  railroads 
located  in  Texas,  the  necessary  capital  for  their  improvement;  be- 
cau.se  if  a  road  was  already  capitalized  to  an  amount  in  excess  of  the 
official  valuation  of  the  State  Commission,  no  further  securities  could 
ordinarily  be  placed  upon  the  property  for  necessary  improvements, 
until  this  deficiency  was  made  good.  Under  these  circumstances 
companies  organized  in  other  states  which  own  lines  in  Texas  need- 
ing added  investments  of  capital  in  order  to  handle  their  traffic  in 
that  state  economically,  frequently  resort  to  a  simple  expedient. 
Instead  of  issuing  securities  of  the  Texas  company  they  pledge  the 
credit  of  the  parent  company  and  put  into  a  collateral  trust  any 
hitherto  unpledged  securities  of  these  Texas  roads  that  they  may 


h.'r ! 


1 


mm 


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REPORT   OF   RAILROAD   SECURITIES   COMMISSION. 


81 


have  in  their  treasury,  and  if  they  have  none,  then  other  securities 
or  property,  thus  issuing  under  the  authority  of  another  state  securi- 
ties whose  proceeds  are  to  be  spent  in  Texas. 

When  the  Chicago,  Milwaukee  &  St.  Paul  Railroad  wished  to 
build  its  Puget  Sound  extension  it  had  to  pass  through  several 
states  whose  laws  forbade  corporations  chartered  under  laws  of 
other  states  to  build  roads  within  their  borders  except  as  a  connec- 
tion or  prolongation  of  a  road  actually  built  to  the  state  line.  In 
order  to  conform  to  these  restrictions,  the  St.  Paul  Road  would 
have  had  to  build  its  line  slowly,  step  by  step,  instead  of  doing 
work  in  several  states  at  once  and  putting  the  road  through  as 
promptly  as  possible.  To  avoid  this  difficulty  it  had  to  organize 
a  separate  company  to  build  the  road  in  each  state  which  had  such 
a  law.  This  in  itself  was  not  a  serious  evil;  it  simply  involved 
additional  expense,  to  have  separate  corporations  do  things  piece- 
wieal  which  might  have  been  done  as  a  unit  without  such  interme- 
diaries. But  it  tended  to  render  state  control  less  effective,  instead 
of  more  so.  The  system  thus  forced  upon  the  St.  Paul  Road  would 
give  every  opportunity  for  deception  to  a  road  which  might  want  to 
deceive. 

Where  a  company  builds  its  own  roads,  it  is  possible  to  find  out 
what  they  cost  and  have  the  matter  properly  entered  in  the  balance 
sheet;  but  where  a  corporation  is  artificially  encouraged  to  divide 
Itself  into  several  parts,  the  parts  that  do  the  constructing  can  sell 
their  finished  roads  to  another  part,  at  an  abnormal  profit.  This 
transaction  may  furnish  the  parent  company  an  excuse  for  an  over- 
issue of  securities.  If  the  securities  thus  over-issued  are  paid  for 
in  full,  it  will  put  a  certain  amount  of  cash  into  the  treasury  of  the 
newly  organized  company  for  which  it  becomes  very  difficult  to 
hold  the  directors  of  the  parent  company  to  strict  account.  If  they 
are  not  fully  paid  for,  it  simply  means  that  the  alleged  profits  of 
the  parent  company  may  be  made  the  excuse  for  furnishing  its 
stockholders,  in  the  shape  of  a  dividend  payable  in  its  own  stock, 
a  number  of  pieces  of  paper  whose  face  value  is  greater  than  the 
amount  actually  contributed. 

15.  OOKTBOL  BY  INTEBCOBFORATE  HOLDING. 

Of  the  total  amount  of  railroad  capital  outstanding  on  June  30, 
1910,  $3,952,000,000,  or  more  than  twenty  per  cent  of  the  whole,  was 
held  by  railroad  companies  themselves.  About  one-third  of  this 
was  bonds,  and  two-thirds  stock.  There  is  also  a  large  additional 
amount  of  railroad  securities  owned  by  various  "holding  com- 
panies," which  are  not,  technically  speaking,  railroad  corporations 
and  do  not  make  return  of  their  capital  to  the  Interstate  Commerce 
Commission,  but  which  control  the  policy  and  direct  the  operation 


of  the  roads  whose  securities  they  have  purchased.  Any  artificial 
stimulus  to  these  intercorporate  holdings  is  a  public  evil.  AVhere 
a  railroad  controls  the  operations  of  another  railroad  by  owning  a 
majority  of  its  stock,  or  where  a  holding  company  controls  the 
operations  of  several  roads  in  the  same  manner,  we  have  all  the  dis- 
advantages of  consolidation,  without  getting  all  of  its  advantages. 
We  get  the  centralization  of  financial  power;  we  do  not  get  all  the 
economy  of  operation  which  should  go  with  it. 

Apart  from  this  general  danger,  we  open  the  way  to  several 
specific  evils. 

Where  a  railroad  controls  the  operations  of  another  road  by  the 
ownership  of  a  majority  of  its  stock,  there  is  constant  danger  that 
the  minority  holders  will  not  be  fairly  treated.  The  road  thus  pur- 
chased has  become  part  of  a  large  system,  and  is  operated  by  the 
representatives  of  the  whole  system.  It  is  almost  certain  that  the 
advantage  ol  the  whole  will  be  preferred  to  the  separate  interests 
of  the  part  in  matters  of  operation,  traffic  and  finance. 

Again,  the  existence  of  two  or  more  companies  under  tlie  same 
management,  having  separate  organizations  but  united  control,  in- 
vites the  concealment  of  financial  transactions  by  the  shifting  of 
chai'ges  from  one  company  to  another.  We  have  already  shown  how 
this  may  happen  in  the  construction  of  a  new  road.  It  is  equally 
possible  in  the  operation  of  an  old  one. 

16.   FINANCIAL  DANGERS. 

A  further  effect  of  intercorporate  holdings  is  to  change  contingent 
t'haFges  into  fixed  ones.  A  railroad  company  buying  the  stock  of 
another  company  almost  always  issues  collateral  trust  or  other  bonds 
to  pay  for  it ;  in  other  words,  it  puts  the  stocks  into  its  own  treasurj- 
and  sells  the  bonds  to  the  public.  As  long  as  the  road  is  prosperous 
this  change  does  little  harm.  In  fact,  it  may  appear  to  do  good. 
When  a  company  has  been  able  to  buy  a  five  per  cent  stock  by  the 
issue  of  its  own  four  and  a  half  per  cent  bonds,  there  is  an  apparent 
profit  of  one-half  per  cent  annually  on  the  transaction  to  the  com- 
pany and  an  apparent  reduction  in  total  charges  which  it  must 
meet.  But  with  any  diminution  in  traffic,  the  bad  effect  of  the  change 
is  at  once  obvious.  The  interest  on  the  bonds  remains  a  fixed  charge 
against  the  company.  The  effect  of  a  loss  of  dividends  w6uld  ha^  e 
been  felt  chiefly  by  the  individual  stockholders;  a  default,  or  even 
fl  threatened  default,  of  interest  has  an  effect  on  the  credit  and  confi- 
dence of  the  country  as  a  whole,  and  may  precipitate  a  financial 
crisis. 

The  extent  to  which  the  credit  of  our  railroads  is  being  pledged 
is  evidenced  by  the  change  in  the  proportion  of  railroad  stocks  and 
bonds    held    by    the    public.      In    1899    these    were    nearly    equal; 


§. 

>* 


22 


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REPORT  OF  RAILROAD  SECURITIES   COMMISSION. 


23 


$4,307,000,000  stocks  and  $4,336,000,000  bonds.  Eleven  years  later 
the  figures  given  by  the  statistician  of  the  Interstate  Commerce  Com- 
mission were  $5,578,000,000  stocks  and  $8,866,000,000  bonds— a  serious 
disproportion.  The  giowth  of  intercorporate  holdings  is  responsible 
tor  a  considerable  })art  of  this  change.  This  disproportionate 
growth  of  fixed  interest-bearing  obligations  as  compared  with  stock 
is  primarily  the  result  of  the  issuance  of  bonds  in  payment  of  roads 
acquired,  and  would  .still  have  taken  place  even  if  title  had  been  taken 
in  fee  instead  of  through  stock  ownership ;  but  the  latter  method,  by 
reason  of  its  facility  for  the  issue  of  collateral  trust  bonds,  has  un- 
fjucstionably  been  an  important  factor  in  creating  this  di.sproportion. 
So  long  as  different  i)arts  of  what  is  naturally  a  connected  system 
of  railr(;ads  are  chartered  by  separate  states  there  are  likely  to  be 
artificial  obstacles  to  consolidation;  and  while  these  obstacles  exist, 
we  shall  find  it  difficult  either  to  check  the  tendency  toward  increased 
intercorporate  holdings,  or  to  deal  with  the  evils  incident  thereto. 
Each  instance  of  intercorporate  holdings  thus  furnishes  an  added 
argument  for  federal  charters. 

17.  ALTERNATIVE  METHODS. 

In  the  present  state  of  the  law,  there  are  two  distinct  methods  by 
which  we  might  avoid  conflicts  between  the  state  and  federal  govern- 
ments in  the  control  of  railroad  stock  and  bond  issues,  and  deal  with 
the  problems  of  construction  and  finance  incident  thereto. 

One  method  relies  on  a  full  interchange  of  views  between  the  Inter- 
state Commerce  Commission  and  the  commissions  of  the  several 
states,  as  a  means  of  securing  harmony.  If  it  is  possiWe  for  the  mem- 
bers of  all  these  different  bodies  to  arrive  at  a  common  understand- 
ing on  a  question  of  public  policy,  they  usually  have  little  trouble 
in  getting  the  necessary  authority  from  Congress  and  the  state  legis- 
latures to  put  a  consistent  policy  into  effect.  This  way  of  doing 
things  was  illustrated  in  the  legislation  regarding  safety  appliances  a 
few  years  ago;  it  is  just  being  illustrated  in  connection  with  control 
of  railroad  accounts  to-day.  In  each  of  these  matters  a  great 
deal  of  trouble  was  made  by  conflicting  requirements;  in  each,  a  full 
discussion  of  the  questions  involved  was  followed  by  a  substantial 
agreement  on  the  main  points,  and  the  good  sense  of  the  several 
commissions  prevented  serious  difficulties  from  being  raised  about 
minor  ones. 

Whether  we  could  secure  a  similar  agreement  on  matters  of  finance, 
where  the  conflict  of  interest  between  different  localities  is  more 
serious  and  the  differences  of  opinion  are  more  fundamental,  is  open 
to  doubt. 

If  the  public  interest  of  the  United  States  as  a  whole  should  be 
jeopardized  by  these  differences,  we  can  perhaps  have  recourse  to  a 


Federal  Incorporation  Act,  which  shall  permit  railroads  to  exchange 
their  state  charters  for  federal  ones.  We  believe  that  such  an  Act 
could  be  so  drawn  as  to  offer  advantages  in  the  conduct  of  interstate 
traffic  without  unduly  conflicting  with  local  interests.  The  most 
important  of  these  advantages  would  be:  (1)  The  right  to  construct 
lines  needed  for  interstate  commerce,  under  proper  local  supervision, 
and  with  proper  regard  for  local  needs,  but  without  the  agency  of 
local  corporate  organizations;  (2)  The  right  to  have  rates  super- 
vised by  a  single  authority  which  could  pay  proper  regard  to  the 
mutual  relations  of  local  traffic  and  interstate  traffic,  instead  of  two 
separate  authorities  dealing  with  the  two  things  independently; 
(3)  An  equitable  .system  of  taxation  which  would  distribute  to  the 
several  states  their  proportionate  parts  of  taxes  levied  on  both  the 
tangible  and  intangible  property  of  the  railroad  by  some  harmonious 
plan. 

It  is  too  early  to  make  definite  choice  between  these  two  alterna- 
tives. But  it  is  not  too  early  to  indicate  the  principles  which  should 
guide  our  legislation  concerning  stocks  and  bonds  in  either  event. 
For  our  progress  toward  putting  these  principles  into  effect  will 
necessarily  be  slow  by  either  method.  If  we  try  to  bring  the  views 
of  different  legislatures  into  harmony,  the  discussion  must  be  de- 
liberate in  order  to  have  any  chance  of  success.  If  we  rely  on  per- 
mission to  exchange  state  charters  for  federal  ones,  we  must  give 
both  the  railroads  and  the  states  time  to  learn  the  wisdom  of  availing 
themselves  of  this  opportunity. 

If  in  the  discussion  that  follows  we  have  seemed  to  have  more  defi- 
nitely in  mind  the  adoption  of  a  federal  charter  than  federal  cojitrol 
of  state  corporations,  it  is  because  this  method  enables  us  to  make 
our  suggestions  in  clearer  and  more  concrete  shape;  the  underlying 
principles  and  aims  would  be  substantially  the  same  in  the  two  cases. 

18.   TREATMENT  OF  EXISTING  ISSUES. 

Whatever  alternative  we  adopt,  any  disturbance  but  a  voluntary 
one  of  the  existing  amounts  or  status  of  bonds  or  stocks  validly 
issued  is  clearly  inadmissible;  and  in  general  there  should  be  as 
little  disturbance  as  possible  of  the  relations  to-day  existing  between 
different  classes  of  security  holders.  These  relations  often  seem 
tinnecessarily  complicated,  both  in  their  provisions  regarding  distri- 
bution of  income  and  in  their  delegation  of  voting  powers.  But  the 
confusion  and  litigation  which  would  result  from  the  attempt  to  dis- 
turb them  would  outweigh  any  possible  good  to  be  obtained. 

The  absence  of  any  attempt  to  base  security  issues  upon  revalua- 
tion will  emphasize  the  true  character  of  our  American  railroad 
stocks,  as  being  essentially  praticipation  certificates  giving  a  right 


24 


iy 


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REPOKT    OF    RAILROAD  SECirRITIES   COMMISSIOX. 


to  a  proportionate  share  of  whatever  profits  may  he  earned,  rather 
than  evidences  that  a  certain  specific  amount  of  money  has  actu- 
ally been  invested  in  the  property. 

19.   PRICE  OF  NEW  ISSUES  OF  STOCK. 

A  most  important  and  difficult  question  is  that  of  the  price  at 
which  new  stock  may  be  issued.  We  believe  that  no  restrictions  ex- 
cept those  of  publicity  should  be  placed  upon  the  power  of  the  direc- 
tors  to  issue  new  stock  pro  rata  to  their  stockholders  at  or  above  par 
even  though  the  price  received  be  less  than  the  existing  market  value' 
of  the  old  stock.  The  experience  of  Massachusetts  has  shown  that 
the  attempt  to  prohibit  the  issue  of  stock  below  its  market  value  has 
hampered  the  investment  of  capital  and  has  distinctly  interfered 
with  the  development  of  facilities.  If  this  has  been  the  experience 
of  Massachusetts,  where  capital  was  abundant,  we  can  hardly  expect 
better  results  in  states  where  capital  is  more  scarce. 

A  further  objection  to  any  attempt  to  compel  the  sale  of  new 
stock  at  a  price  above  par  is  that  it  implies  a  certain  warrant  that 
this  value,  thus  publicly  fixed,  will  be  maintained  in  the  future,  on 
the  old  stock  as  well  as  the  new.  In  thus  attempting  to  limit  profits, 
it  may  actually  tend  to  guarantee  them. 

The  question  whether  the  directors  should  be  allowed  to  issne 
stock  below  par  is  a  harder  one  to  answer.  On  the  face  of  the  matter 
it  seems  as  though  the  requirement  that  no  stock  should  be  sold  at 
less  than  par  was  a  fundamental  principle  of  sound  finance.  So  it  is, 
if  it  results  in  the  sale  of  stock  at  par;  not  so,  if  it  results  in  the  sale 
of  bonds  at  a  discount.  If  a  road  whose  stock,  for  any  reason  what- 
soever, sells  below  par  is  prohibited  from  issuing  stock  at  less  than 
par,  it  means  that  it  must  raise  all  its  money  by  bonds.  It  is  com- 
pelled to  go  more  and  more  deeply  into  debt.  The  worse  the  finan- 
cial position  of  the  road,  the  stronger  is  the  compulsion  and  the 
heavier  are  the  interest  charges  on  the  bond.  To  compel  the  weaker 
roads  to  pursue  their  present  policy  of  issuing  fixed  interest-bearing 
obligations  by  reason  of  their  inability  to  sell  stock  at  par  may 
before  long,  by  reason  of  a  large  crop  of  receiverships,  result  in 
intensifying  the  acuteness  of  the  next  panic  and  in  prolonging  the 
subsequent  business  depression. 

If  the  stock  bears  upon  its  face  the  statement  that  each  share  rep- 
resents a  contribution  of  one  hundred  dollars  or  any  other  specified 
sum  which  constitutes  its  par  value,  we  see  no  easy  way  of  avoiding 
this  difficulty.  If  a  document  says  one  hundred  dollars  has  been 
paid,  one  hundred  dollars  ought  to  he  paid.  The  most  that  can 
properly  be  done  is  to  allow  companies  which  cannot  sell  such  stock 
at  par  to  arrange  for  the  "amortization,"  or  gradual  cancellation,  of 


REPOBT  OF   RAILROAD   SECURITIES   COMMISSION. 


u 


any  necessary  discount  by  appropriating,  out  of  future  income  or 
surplus  which  may  accrue  subsequent  to  the  issue  of  such  stock  an 
annual  sum  having  precedence  over  dividend  payment,  to  be  so  ap- 
plied on  capital  account  as  to  make  the  deficiency  good  in  a  period  of 
no  very  great  length.  If  proper  provision  is  made  for  thus  can- 
celling or  amortizing  this  deficiency,  such  stock  may  properly  be 
made,  by  general  law,  non-assessable.  The  reluctance  of  directors  to 
impair  their  ability  to  pay  dividends  for  a  term  of  years  will  prevent 
the  abuse  of  this  power.  We  believe  the  issue  of  stock  at  a  discount, 
under  safeguards  like  these,  to  be  far  preferable,  in  the  interest  of 
the  public,  to  the  sale  of  bonds  at  a  high  rate  of  interest,  or  what 
amounts  to  the  same  thing,  at  a  large  discount. 

20.   SHABES  WITHOUT  PAB  VALUE. 

We  do  not  believe  that  the  retention  of  the  hundred  dollar  mark, 
or  any  other  dollar  mark,  upon  the  face  of  the  share  of  stock,  is 
of  essential  importance.  We  are  ready  to  recommend  that  the  law 
should  encourage  the  creation  of  companies  whose  shares  have  no 
par  value,  and  permit  existing  companies  to  change  their  stock  into 
shares  without  par  value  whenever  their  convenience  requires  it. 
After  such  conversion  any  new  shares  could  be  sold  at  such  price 
as  was  deemed  desirable  by  the  board  of  directors,  with  the  require- 
ment of  publicity  as  to  the  proceeds  of  the  sale  of  such  shares  and 
as  to  the  disposition  thereof;  giving  to  the  old  shareholders,  except 
in  some  cases  of  reorganization  or  consolidation,  prior  rights  to 
subscribe  pro  rata,  if  they  so  desired,  in  proportion  to  the  amount 
of  their  holdings. 

As  between  the  two  alternatives  of  permitting  the  issue  of  stock 
below  par,  or  authorizing  the  creation  of  shares  without  par  value, 
the  latter  seems  to  this  Commission  the  preferable  one.  It  is  true 
that  it  will  be  less  easy  to  introduce  than  the  other,  because  it  is 
less  in  accord  with  existing  business  habits  and  usages:  but  it  has 
the  cardinal  merit  of  accuracy.  It  makes  no  claims  that  the  share 
thus  issued  is  anything  more  than  a  participation  certificate. 

The  objections  to  the  creation  of  shares  without  par  value  are  two 
in  number:  First,  that  their  issue  will  permit  inflation,  by  making 
it  easy  to  create  an  excessive  number  of  shares :  and  second,  that  it 
will  produce  a  division  of  roads  into  two  classes,  those  whose  shares 
ha^e  a  par  value  and  those  whose  shares  have  not.  The  second  of 
these  objections  does  not  appear  to  be  a  very  serious  one.  There  are 
listed  on  the  stock  exchanges  today,  side  by  side  with  one  another, 
shares  of  the  par  value  of  one  hundred  dollars,  shares  of  the  par 
value  of  fifty  dollars,  shares  with  very  much  smaller  par  value,  and 
a  few,  like  the  Great  Northern  Ore  Certificates,  with  no  par  value 
at  all.     The  share  sells  in  each  case  simply  for  what  the  public 


26 


REPORT  OF   RAILROAD   SECURITIES   COMMISSION. 


supposes  it  to  be  worth  as  a  share.  The  danger  of  inflation  deserres 
more  serious  consideration.  We  believe,  however,  that  it  is  more 
apparent  than  real,  because  shareholders  will  be  jealous  of  per- 
mitting other  shareholders  to  acquire  shares  in  the  association  except 
at  full  market  value,  and  will  not  permit  the  issue  of  such  shares 
to  themselves  at  prices  so  low  as  seriously  to  impair  the  market  or 
other  value  of  their  holdings.  Shares  either  with  or  without  par 
value,  and  whether  sold  at  par  or  above  par  or  below  it,  should, 
except  in  cases  of  consolidation  and  reorganization,  be  offered  in  the 
first  instance  to  existing  shareholders  pro  rata. 

The  issue  of  stock  without  par  value  offers  special  facilities  for 
consolidation  and  reorganization. 

Where  two  roads  have  consolidated  whose  shares  have  different 
market  values,  it  has  been  the  custom  to  equalize  the  difference  by 
the  issue  of  extra  shares  of  the  consolidated  company  to  the  owners 
of  the  higher  priced  stock.  This  practice  has*  always  tended  to  pro- 
duce  increase  of  capital  issues,  and  may  readily  cause  the  new  stock 
to  be  issued  for  a  consideration  less  than  its  par  value.  The  only 
alternative  was  to  scale  down  some  of  the  old  stocks;  and  this  often 
involved  serious  difficulties,  both  of  business  policy  and  of  law.  By 
the  simple  expedient  of  omitting  the  dollar  mark  from  the  new 
shares,  the  number  can  be  adjusted  to  the  demands  of  financial 
convenience,  without  danger  of  misrepresentation  or  suspicion  of 
unfairness  to  anyone. 

In  the  case  of  reorganizations,  the  advantage  of  shares  without 
par  value  is  even  more  obvious.  It  is  here  that  the  necessity  and 
justice  of  getting  money  from  stockholders  is  greatest.  It  is  here 
that  the  impossibility  of  getting  them  to  pay  par  for  new  shares  is 
most  conspicuous.  We  believe  that  in  such  cases  the  public  interest 
would  be  subserved  and  the  speedy  rehabilitation  of  the  roads  pro- 
moted, by  requiring  the  conversion  of  the  common  stock  and  encour- 
aging the  conversion  of  the  preferred  stock  into  shares  without  par 
value:  the  certificates  simply  indicating  the  proportionate  or  prefer- 
ential claims  of  the  holders  upon  assets  and  upon  such  profits  as 
might  from  time  to  time  be  earned. 

All  of  these  considerations  seem  to  apply  with  equal  force  to  the 
securities  of  railroads  under  state  incorporations,  and  we  believe  the 
laws  of  the  several  states  could  with  advantage  be  modified  so  as  to 
provide  for  the  issuance  of  stock  without  par  value. 

21.  NEW  ISSUES  OF  BONDS. 

It  seems  to  be  generally  agreed  that  no  limitation  should  be  placed 
on  the  price  at  which  bonds  can  be  sold,  but  any  discount  should  be 
cancelled  or  amortized  during  the  life  of  the  bonds  by  the  appro- 
priation each  year,  out  of  annual  income  or  surplus  accumulated 


REPORT  OF   RAILROAD   SECURITIES   COMMTSSTOX. 


27 


after  the  issue  of  the  bonds,  of  not  less  than  the  proportionate  amount 
of  the  discount.  In  the  case  of  convertible  bonds,  the  same  provi- 
sion should  hold  good,  with  the  additional  restriction  that  after  ccm- 
version  the  laws  governing  the  amortization  of  discount  on  stock 
sold  below  par  should  apply  also  to  the  unamortized  discount'on  con- 
vertible bonds.  While  the  convertible  bonds  themselves  may  be  sold 
below  par,  the  conversion  price  of  the  stock  should  equal  its  face 
value;  except  of  course  in  case  of  shares  without  par  value,  where 
no  limit  as  to  conversion  price  is  necessary,  nor  any  amortization 
after  conversion.  The  premium  on  bonds  redeemed  before  maturity 
or  the  unamortized  discount  on  bonds  thus  redeemed  should  be 
charged  to  profit  and  loss,  and  provision  made  for  the  gradual  can- 
cellation of  this  charge  out  of  income. 

Issues  of  convertible  bonds  should  be  offered  to  stockholders  pro 
rata,  in  the  same  manner  as  stock  itself,  to  the  extent  to  which  they 
may  choose  to  avail  themselves  of  the  privilege  of  subscription. 

22.   DIVIDENDS  AND  RESERVE  FUNDS. 

No  attempt  should  be  made  by  statute  to  limit  railroad  profits  to 
a  fixed  percentage,  or  to  treat  a  high  cash  dividend  as  necessarily 
indicating  extortion.  Railroad  charges  must  be  reasonable;  but  to 
try  to  control  rates  by  arbitrarily  limiting  profits  is  to  put  the 
manager  who  makes  his  profit  by  efficiency  and  economy  on  the 
same  level  as  the  one  who  tries  to  accomplish  the  same  result  through 
extortionate  charges. 

Scrip,  bond  and  stock  dividends  should  be  prohibited.  They  are 
commonly  justified  on  the  theory  that  the  company  has  in  times 
past  put  earnings  into  the  property  which  it  might  have  divided 
among  the  stockholders,  and  that  the  scrip  dividend  merely  re- 
imburses the  stockholders  for  what  they  have  put  into  the  road. 
But  these  sums  were  put  in,  either  to  make  depreciation  and  ob- 
solescence good,  or  as  actual  additions  to  the  property.  In  the 
former  case  the  capital  account  ought  not  to  be  increased.  In  the 
latter  case  any  such  increase  gives  color  to  the  claim  that  the  ship- 
pers have  been  taxed  to  pay  for  the  improvement  of  the  property, 
and  that  the  stockholders  have  appropriated  the  result. 

Many  of  the  stock  dividends  in  past  years  have  represented  an 
increase  in  the  value  of  the  property,  not  paid  for  either  by  in- 
vestors or  by  shippers,  but  due  simply  to  the  foresight  of  the 
management  in  locating  and  organizing. its  business  wisely.  Under 
these  circumstances  a  stock  dividend  to  represent  this  increased 
value  may  possibly  have  been  justified,  but  it  is  far  better  to  let  the 
increased  value  be  shown  by  a  higher  rate  of  dividend  on  the  exist- 
ing shares  of  stock,  instead  of  by  an  addition  to  their  nominal 
amount. 


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28 


KEPOBT  OF  RAILfiOAD  SECURITIES  COMMISSION. 


If  we  prohibit  scrip  dividends,  we  can  permit  the  creation  of 
proper  reserve  funds  without  having  them  regarded  with  suspicion 
as  being  a  pretext  for  future  issues  of  unpaid  stock.  Sound  finance 
demands  that  the  companies  should  set  aside  such  funds,  out  of 
income,  to  "defray  the  cost  of  progress."  They  can  thus  provide 
against  obsolescence,  or  make  improvements  which  add  nothing  to 
the  earning  capacity  of  the  property  and  ought  not  therefore  to  be 
made  the  basis  of  increased  capital  liability. 

Failure  to  encourage  the  creation  of  reserve  funds  out  of  surplus 
earnings  would  cause  a  constant  increase  of  fixed  charges,  already 
heavy  enough.  Whatever  gain  there  might  be  in  a  present  lower- 
ing of  rates  would  be  merely  temporary.  Investors  and  shippers 
would  alike  be  misled;  the  former  into  a  fancied  security  as  to  the 
permanence  of  dividends,  the  latter  into  the  belief  that  such  reduc- 
tion in  rates  was  permanent.  Ultimately  such  a  course  would 
lead  either  to  higher  rates  or  to  steadily  diminishing  dividends  and 
consequent  impaired  credit.  Railroad  credit  is  an  important  asset 
lo  the  entire  country,  and  it  should  not  be  wasted.  In  encouraging, 
therefore,  the  creation  of  reserve  funds,  we  are  only  suggesting  that 
the  present  generation  shall  not  be  unmindful  of  its  obligations  to 
future  users  of  transportation. 

Cash  dividends  are  not  likely  to  be  as  large  as  scrip  dividends, 
because  the  former  involve  the  distribution  of  a  corresponding  amount 
of  cash,  while  the  latter  do  not.  Under  these  circumstances  the  pro- 
hibition of  scrip  dividends  should  of  itself  encourage  the  creation 
of  proper  reserve  funds.  In  this  as  in  other  respects,  all  these  three 
proposals — freedom  from  arbitrary  restriction  of  profits,  prohibition 
of  scrip  dividends,  and  creation  of  proper  reserve  funds — hang 
floselv  together.  Any  one  by  itself  mav  be  of  doubtful  value. 
Taken  together,  they  should  produce  a  result  advantageous  to  all. 

23.  TREATMENT   OF  INTERCORPORATE   HOLDINGS. 

Whatever  may  be  the  evils  due  to  such  holdings,  an  unqualified 
prohibition  of  the  ownership  of  stock  of  one  road  by  another  involves 
too  much  disturbance  of  existing  relations  to  warrant  us  in  advo- 
cating it.  Much  will  be  accomplished  if  we  do  away  with  the 
unnecessary  extension  of  these  holdings  and  provide  for  equitable 
dealings  between  the  representatives  of  the  purchasing  company  on 
the  one  hand  and  the  holdei-s  of  minority  interests  on  the  other. 

If  a  railrood  company  is  allowed  to  build  the  necessary  lines  int<» 
other  states  for  the  handling  of  interstate  business,  instead  of  being 
compelled  to  create  some  separate  company  to  do  this,  one  fruitful 
reason  for  intercorporate  holdings  will  be  done  away  with.  If  we 
have  full  requirements  of  publicity  regarding  the  purchase  of  stock 
if  other  companies,  and  have  the  disclosure  of  <lirectors'  interebts 


REPORT   OF   RAILROAD   SECURITIES   COMMTSSION. 


29 


therein,  another  source  of  danger  is  avoided.  If,  finally,  we  can 
lemove  artificial  obstacles  to  consolidation  by  permitting  the  issue 
of  shares  without  par  value,  we  shall  be  able  to  avoid  the  expense 
of  double  corporate  organization  where  a  single  company  would 
better  serve  public  economy  and  convenience.  In  this  and  other 
respects,  many  of  our  difficulties  are  due  to  the  attempt  to  rely  upon 
competition  in  a  business  which,  in  private  hands,  should  be  treated 
in  essentials  as  a  regulated  monopoly. 

Any  company,  or  group  of  companies,  which  has  purchased  a  ma- 
jority of  the  stock  of  any  existing  road  may  properly  be  required  to 
buy  the  minority  stock  at  the  same  price  as  that  paid  for  the  majority 
stock  where  the  price  has  been  uniform.  If  the  price  has  not  been 
uniform,  the  purchase  should  be  either  at  the  average  price  paid 
for  such  holdings  or  at  a  price  to  be  fixed  by  appraisal,  at  the  option 
of  the  minority  stockholders. 

If  a  company  has  acquired  control  of  the  common  stock  of  another, 
but  not  of  its  preferred,  it  should  be  required  either  to  buy  the 
preferred  stock  or  to  make  the  preference  cumulative.  For  the 
continued  existence  of  a  non-comulative  preference  under  such 
conditions  will  offer  constant  temptations  to  unfair,  dealing,  if  not  to 
actual  fraud.  ' 

In  order  to  avoid  vexatious  opposition  to  consolidation  by  a  mi- 
nority it  should  be  possible,  after  such  an  offer  had  been  fairly  made, 
to  convey  the  property  by  three- fourths  vote  of  the  shareholders 
and  dissolve  the  corporation.  The  purchase  of  less  than  a  majority 
of  the  stock  of  one  line  by  another  (except  as  one  of  a  group  of  rail- 
roads jointly  holding  the  stock  of  some  connecting  company)  should 
be  discountenanced  and  as  far  as  possible  prohibited. 

What  we  have  here  said  applies  only  to  intercorporate  holdings 
arising  out  of  railroad  affiliations  permissible  under  existing  statutes 
and  not  in  conflict  with  declared  principles  of  public  policy. 

24.   REASONABLE   AND  UNREASONABLE   EXPECTATIONS. 

An  agreement  on  these  lines  will  enable  us  to  avoid  many  existing 
conflicts  of  jurisdiction,  and  will  incidentally  promote  honest  and  re- 
sponsible management  of  our  railroads  in  every  department.  So  far 
as  it  does  this,  it  will  be  a  good  thing  both  for  investors  and  for  ship- 
pers. But  the  extent  to  which  a  law  regarding  security  issues,  how- 
ever well  drawn,  can  protect  either  the  investor  or  the  shipper  is 
quite  limited. 

Most  of  those  who  advocate  legislation  on  this  subject  hope  for 
wider  results  than  can  possibly  be  reached  by  any  such  means.  One 
man  expects  that  a  good  law  on  stock  and  bond  issues  will  be  of  great 
service  in  enabling  courts  and  commissions  to  protect  the  shippers 
against  overcharge.    A  second  believes  that  both  investors  and  ship- 


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REPORT   or  RAILROAD   SECURITIES   COMMISSION, 


REPORT   OF   RAILROAD   SECURITIES   COMMISSION. 


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pers  can  be  benefited  by  an  abolition  of  the  profits  of  the  promoter. 
A  third  thinks  that  our  securities  can  be  standardized,  so  that  the 
investors  will  be  sure  of  getting  the  returns  which  are  promised 
them.  A  fourth  demands  that  public  confidence  be  so  restored  that 
the  community  may  get  the  railroad  capital  it  requires.  The  attain- 
ment of  these  results  is  beyond  the  power  of  an  Act  of  Congress. 
The  chief  thing  that  such  an  Act  can  do  is  to  remove  obstacles  which 
bad  laws  and  worse  practices  have  placed  in  our  way. 

The  attempt  to  render  direct  protection  to  the  shipper  by  a  federal 
statute  regarding  stock  and  bond  issues  is  attended  with  difficulties 
which  are  almost  insuperable. 

In  the  case  of  Smyth  vs.  Ames  the  Supreme  Court  of  the  United 
States  held  that  the  amount  of  bonds  and  stocks  outstanding  was  but 
one  among  many  matters  to  be  considered  in  deciding  whether  rates 
were  reasonable.  This  therefore  is  the  law  as  determined  by  prece- 
dent; and  it  is  fortunate  that  the  dictates  of  precedent  coincide  with 
those  of  business  sense.  The  attempt  to  make  the  face  value  of  se- 
curities issued  the  determining  factor  in  rates  would  result  in  putting 
a  premium  on  roads  which  had  been  speculatively,  not  to  say  dis- 
honestly, built  or  managed,  by  allowii^g  them  to  charge  higher  rates 
on  account  of  the  inflated  capital  thus  produced.  And,  wholly  apart 
from  any  such  speculation  or  dishonesty,  the  amount  of  stock  capital 
and  bonded  debt,  even  if  paid  for  at  par,  is  a  very  inaccurate  and 
inof)mplete  criterion  of  the  value  of  the  property  devoted  by  its  own- 
ers to  public  use.  It  has  at  best  only  a  historical  importance,  as 
showing  what  property  was  or  purported  to  be  worth  at  the  time  of 
the  incorporation.  It  does  not  show  what  it  is  worth,  or  what  rates 
may  properly  be  charged  for  its  use,  ten  years  later  or  even  one  year 
later. 

25.   PROMOTERS'  PROFITS  AND  SERVICES. 

We  are  told  that  the  profit  of  the  promoter  represents  a  wholly 
unnecessary  burden  upon  the  American  public,  and  that  so  far  hs 
this  profit  can  be  done  away  with  it  will  be  good  for  all  parties. 
Neither  of  these  statements  is  quite  true.  The  promoters,  using  the 
term  in  a  broad  sense,  may  be  divided  into  two  classes :  constructors 
who  build  a  road  whose  future  is  uncertain,  in  the  expectation  of 
selling  the  stock  for  more  than  it  cost  them;  and  financiers  who 
induce  the  public  to  buy  the  bonds  of  such  roads.  Both  of  these 
classes,  if  they  do  their  work  honestly,  render  useful  services  to  the 
public.  The  constructor  gives  our  undeveloped  districts  the  benefit 
of  new  roads,  which  they  would  not  get  without  his  intervention; 
and  if  he  does  his  business  well  he  builds  the  roads  more  economi- 
cally than  anybody  else  could.     The  financier  renders  an  equally 


important  service  in  collecting  the  capital  of  the  investors  to  build 
new  railroads  or  improve  old  ones.  On  the  Continent  of  Europe 
this  is  done  by  the  banks.  The  great  banking  concerns  of  Germany 
use  a  very  considerable  part  of  their  deposits  in  carrying  industrial 
enterprises  during  their  initial  stages  before  their  merits  have  been 
deuKmstrated,  and  then  disposing  of  them  to  the  actual  investor  at 
a  profit  in  order  to  set  their  capital  free  for  the  floating  of  new 
concerns.  But  in  the  United  States  the  power  of  the  banks  to  do 
this  is  limited  by  law  and  by  custom;  and  so  far  as  they  either  can- 
not or  do  not,  it  must  be  done  by  financial  houses  especially  organ- 
ized for  the  purpose. 

Our  American  system  undoubtedly  involves  grave  possibilities  of 
fraud.  The  man  who  is  constructing  a  road  is  tempted  to  persuade 
people  to  loan  him  money  on  inade(|uate  security.  The  financiers 
may  be  tempted  to  wink  at  this  deception.  Worst  of  all,  the  roads 
thus  built  may  be  built  for  sale  at  an  inflated  valuation.  The  pro- 
moter may  obtain  his  profit,  not  from  the  legitimate  increase  of  the 
value  of  his  property,  but  from  his  power  to  persuade  the  manage- 
ment of  some  larger  system  to  buy  the  branch  road  for  more  than  it 
IS  really  worth.  These  are  evils  which  publicity  would  do  much  to 
check.  Where  there  is  no  fraud,  the  promoter  renders  a 'service  for 
which  he  is  entitled  to  fair  remuneration. 

26.   STANDARDIZATION   OF  RAILROAD   SECURITIES. 

We  are  told  that  if  it  was  possible  to  standardize  food  by  a  pure 
food  law,  it  ought  to  be  possible  to  standardize  railroad  securitie^s  by 
a  securities  law.  It  is  possible — to  the  same  extent  and  no  more. 
The  pure  food  law  enables  a  man  to  know  what  he  is  buying.  It 
does  not  certify  that  the  thing  he  buys  is  good  for  him.  That  is  left 
to  his  intelligence.  The  government  cannot  protect  the  investors 
against  the  consequences  of  their  unwisdom  in  buying  unprofitable 
bonds,  any  more  than  it  can  protect  the  consumers  against  the  con- 
sequences of  their  unwisdom  in  eating  indigestible  food.  Unless  we 
are  prepared  to  have  government  guarantees  of  interest  on  railroad 
investments — a  most  questionable  proposal — the  only  way  in  which 
we  can  standardize  railroad  mortgages  is  the  one  which  we  use  with 
savings  bank  mortgages.  We  can  insist  on  double  security.  We  can 
say  that  at  least  half  the  capital  of  a  railroad  must  be  subscribed  by 
stockholders,  and  that  not  more  than  half  may  be  raised  by  borrow- 
ing— a  difficult  requirement  under  existing  conditions.  Until  we 
are  prepared  to  pass  some  law  of  this  kind  the  investor  must  depend 
upon  his  own  intelligence  to  protect  him  from  loss.  The  function  of 
the  government  is  to  see  that  correct  information  is  available. 


y 


! 


tit-gy. 


32 


REPORT   OF   RAILROAD   SECURITIE^   COMMISSION. 
27.   BESTOEATION  OF  PUBLIC  CONFIDENCE. 


REPORT  OF  RAILROAD   SECURITIES  COMMISSION. 


33 


There  was  a  time  when  the  efforts  of  the  banking  authorities  in 
most  of  the  states  were  directed  toward  getting  the  discount  rates  as 
low  as  possible.  The  bank  commissioners  in  those  days  regarded 
themselves  as  the  representatives  of  the  merchants  who  wanted 
loans.  They  made  little  or  no  attempt  to  safeguard  the  stockholdei-s 
and  creditors  of  the  bank.  Those  were  the  days  of  wildcat  banking. 
The  country  has  passed  beyond  that  period— not  solely  or  primarily 
because  it  obtained  a  national  banking  law,  but  because  it  admin- 
istered that  law  with  due  regard  to  the  security  of  the  stockholders 
and  creditors  of  the  bank  as  well  as  its  customers.  We  have  not 
developed  our  ideas  of  railroad  management  as  far  as  we  have  devel- 
oped our  ideas  of  bank  management.  The  subject  is  a  more  complex 
one.  The  apparent  conflict  of  interests  between  the  management 
and  the  customers  is  greater  with  a  railroad  than  with  a  bank. 
As  a  result  of  this  misunderstanding!:,  the  necessary  development  of 
railroad  facilities  is  now  endangered  by  the  reluctance  of  investors 
to  purchase  new  issues  of  railroad  securities  in  the  amounts  re- 
quired. This  reluctance  is  likely  to  continue  until  the  American 
public  understands  the  essential  community  of  interest  between  ship- 
per and  investor  and  the  folly  of  attempting  to  protect  the  one  by 
taking  away  the  rewards  of  good  management  from  the  other. 

We  are  told  that  a  good  law  regarding  national  incorporation  would 
of  itself  create  public  confidence.  This  is  an  over-statement.  Such 
a  law  would  remove  one  set  of  sources  of  distrust,  but  there  is  an- 
other set,  more  fundamental,  which  can  only  be  removed  by  the  ex- 
ercise of  intelligence  on  the  part  of  the  American  people  as  a  whole. 

28.  AMOUNT   OF   ADDITIONAL  CAPITAL  BEQUIBED. 

There  is  a  widespread  belief,  based  on  imperfect  examination  of 
the  evidence,  that  the  amount  of  capital  needed  for  the  future  de- 
velopment of  our  railroad  system  is  small  in  proportion  to  that  which 
has  been  required  in  the  past ;  that  the  profits  on  such  added  invest- 
ments of  capital  are  reasonably  well  assured ;  and  that  we  can  there- 
fore fix  attention  predominantly  if  not  exclusively  on  the  needs  of 
the  shipper  without  interfering  with  the  necessary  supply  of  new 
noney  from  the  investors. 

It  is  quite  possible  that  the  building  of  additional  railroad  mileage 
will  be  far  less  rapid  in  the  future  than  it  has  been  in  the  past, 
but  the  capital  needed  for  the  development  and  the  improven^ent 
of  the  mileage  already  existing  is  enormous,  even  if  we  built  no 
new  mileage  at  all.  The  outstanding  stock  and  debt  of  the  railways 
in  the  United  States  averages  less  than  $60,000  a  mile  of  line. 
This  figure  is  bound  to  be  greatly  increased  in  the  immediate  future. 


As  our  population  grows  denser,  we  shall  need  more  and  more  to 
approximate  European  standards  of  construction  by  the  increased 
amount  of  double  track,  the  abolition  of  grade  crossings,  the  develop- 
ment  of  station  facilities  both  for  passengers  and  for  freight,  and 
many  other  improvements  scarcely  less  fundamental.    While  our 
railroads  are  perhaps  even  better  equipped  than  those  of  Europe 
for  the  economical  handling  of  large  masses  of  long  distance  freight, 
they  are  far  from  being  adequately  provided  with  appliances  to 
secure  the  convenience  of  the  public  or  the  safety  of  passengers  and 
employees.    The  cost  of  all  these  things  is  very  great.    The  average 
capitalization  per  inile  of  railroads  in  Germany  is  $109,000,  in  France 
$137,000,  in  Belgium  $177,000,  in  Great  Britain  $265,000 ;  and,  con- 
trary to  the  commonly  received  opinion,  much  of  this  excess  of  cost 
as  compared  with  American  roads,  is  due  to  other  causes  than  the 
price  of  real  estate— an  item  in  which  our  companies  have  had  a 
great  advantage.    The  cost  of  European  roads  has  been  largely  due 
to  improvements  which  we  have  not  yet  made  and  many  of  which 
we  must  make  in  the  future  as  population  grows  denser.     The  thou- 
sands of  millions  of  dollars  needed  for  these  purposes  must  be  raised 
by  the  sale  of  securities. 

29.   PRESENT  RETURN  AND  FUTURE  SECURITY. 

Neither  the  rate  of  return  actually  received  on  the  par  value  of 
American  railroad  bonds  and  stocks  today,  nor  the  security  which  can 
be  offered  for  additional  railroad  investments  in  the  future,  will 
make  it  easy  to  raise  the  needed  amount  of  capital. 

The  ratio  of  interest  and  dividends  to  outstanding  bonds  and  stocks 
of  American  railroads  is  not  quite  four  and  a  half  per  cent  in  each 
case.  The  average  ratio  of  dividends  to  the  capital  of  national 
banks  is  between  ten  and  eleven  per  cent.  If  it  be  objected  that  the 
value  of  the  stocks  of  our  railroads  is  in  considerable  measure  due 
to  the  growth  of  the  community  rather  than  to*  the  cash  originallw 
invested,  and  that  the  bonds  and  stocks  of  railroads  should  there- 
fore be  compared  with  the  combined  capital  and  surplus  of  t*^ 
national  banks,  we  find  that  these  banks  have  for  the  last  three  yeaiil 
maintained  an  average  ratio  of  dividends  to  capital  and  surplus 
combined  of  over  six  and  a  half  per  cent.  If  we  look  not  at  the 
sums  divided,  but  at  the  sums  earned,  we  find  the  same  difference  of 
profit  in  favor  of  the  banks. 

Nor  can  the  security  which  most  of  our  railroads  offer  be  regarded 
as  exceptional.  The  underlying  bonds  of  the  older  systems  are 
doubtless  secure.  It  is  not  probable  that  even  a  grave  commercial 
crisis  will  affect  the  return  of  a  trunk  line  first  mortgage.  But  very 
little  of  the  new  capital  can  be  raised  on  securities  of  this  kind. 
Most  of  it  must  come  either  from  bonds  which  will  not  be  a  first  lien 

H.  Doc.  256, 62-2 3 


» 


1 


m 


■i. -?«■«: 


34 


REPORT  OF   RAILROAD  SECURITIES   COMMISSION. 


REPORT  OF  RAILROAD  SECURITIES   COMMISSION. 


35 


'■KM 


for  many  years,  or  from  new  issues  of  capital  stock.  The  investors 
in  these  securities,  and  especially  in  stocks,  take  risks  which  cannot 
be  accurately  forecast.  Apart  from  probable  fluctuations  in  traffic 
and  possible  increases  in  cost  of  operation,  new  inventions  may  at 
any  time  render  much  of  their  present  plant  antiquated.  The  sub- 
stitution of  electricity  for  steam  is  but  a  type  of  the  many  changes 
which  railroads  may  be  compelled  to  make,  any  one  of  which  might 
involve  large  additions  to  their  cost  without  the  assurance  of  cor- 
responding additions  to  their  return. 

30.   WHAT   CONSTITUTES  A   REASONABLE  RETURN. 

We  hear  much  about  a  reasonable  return  on  capital.  A  reason- 
able return  is  one  which  under  honest  accounting  and  responsible- 
management  will  attract  the  amount  of  investors'  money  needed  for 
the  development  of  our  railroad  facilities.  More  than  this  is  an 
unnecessary  public  burden.  Less  than  this  means  a  check  to  rail- 
road construction  and  to  the  development  of  traffic.  Where  the  in- 
vestment is  secure,  a  reasonable  return  is  a  rate  which  approximates 
the  rate  of  interest  which  prevails  in  other  lines  of  industry.  Where 
the  future  is  uncertain  the  investor  demands,  and  is  justified  in 
demanding,  a  chance  of  added  profit  to  compensate  for  his  risk. 
We  can  not  secure  the  immense  amount  of  capital  needed  unless  we 
make  profits  and  risks  commensurate.  If  rates  are  going  to  be 
reduced  whenever  dividends  exceed  current  rates  of  interest,  in- 
vestors will  seek  other  fields  where  the  hazard  is  less  or  the  oppor- 
tunity greater.  In  no  event  can  we  expect  railroads  to  be  developed 
merely  to  pay  their  owners  such  a  return  as  they  could  have  ob- 
tained by  the  purchase  of  investment  securities  which  do  not  involve 
the  hazards  of  construction  or  the  risks  of  operation. 

31.  POINTS  TO  BE  EMPHASIZED. 

In  concluding  its  report  your  Commission  desires  to  emphasize 

the  following  points : 

1st.  The  questions  presented  for  its  consideration  do  not  include 
or  involve  a  comparison  of  the  policy  of  governmental  ownership 
of  railroads,  with  the  policy  of  private  ownership  in  any  of  its 
forms.  The  Act  of  Congress  under  which  the  Commission  was 
appointed  provides  that  its  duty  shall  be  "  to  investigate  qu.estions 
pertaining  to  the  issuance  of  stocks  and  bonds  by  railroad  corpora- 
tions, subject  to  the  provisions  of  the  Act  to  regulate  commerce, 
and  the  power  of  Congress  to  regulate  or  affect  the  same."  The 
Commission  has,  therefore,  concerned  itself  exclusively  with  ques- 
tions which  arise  under  a  system  of  governmental  regulation  of 
privately  owned  railroads. 


2nd.  It  has  not  seemed  to  the  Commission  profitable  to  consider 
at  length  what  the  government  might  have  done  in  times  past,  nor 
to  enter  upon  a  historical  recital  of  incidents  arising  out  of  the 
unregulated  issue  of  securities.  Kailroad  development  has  gone  so 
far  and  such  a  vast  volume  of  securities  has  already  been  issued, 
that  the  only  questions  of  real  importance  today  are  whether,  under 
the  conditions  which  now  exist,  it  is  desirable  for  the  federal  gov- 
ernment to  regulate  the  issue  of  future  securities,  and  if  so,  to  what 
extent  and  in  what  manner.  In  other  words,  the  large  volume  and 
complex  relationships  of  the  outstanding  securities,  the  issue  of 
which  has  not  been  regulated  at  all  by  the  federal  government  and 
has  not  been  effectively  regulated  by  the  state  governments,  make  it 
impossible  to  treat  the  question  of  present  or  future  regulation  as 
it  might  have  been  treated  if  these  securities  were  not  already  in 
existence. 

3rd.  It  would  have  been  equally  unprofitable  for  the  Commission 
to  enter  upon  an  elaborate  discussion  of  the  power  of  Congress  to 
regulate  or  affect  railroad  securities,  at  a  time  when  important  cases 
are  pending  which  will  go  far  to  determine  the  scope  and  extent  of 
federal  authority  in  this  and  other  closely  related  subjects.     Such  a 
discussion  could  only  state  the  opinion  of  the  members  of  the  Com- 
mission regarding  the  constitutional  power  of  Congress.     The  issues 
themselves  will  remain  undecided  until  the  Supreme  Court  decides 
them.     Whatever  may  be  the  ultimate  outcome,  the  present  fact 
which  faces  us  is  tliat  constitutional  questions  of  far-reaching  conse- 
quence are  to-day  unsettled  and  must  remain  so  for  a  considerable  time. 
Under  these  circumstances,  any  attempt  by  Congress  to  adopt  the 
policy  of  Federal  regulation  to  the  exclusion  of  state  regulation, 
would  be  premature.     On  the  other  hand,  to  superimpose  Federal 
regulation  upon  state  regulation  would  add  to  conflicts  and  complex- 
ities which,  in  the  public  interest,  should  be  diminished  rather  than 
increased.     Your  Commission  believes  that  for  the  present  an  earnest 
effort  should  be  made  on  the  part  of  state  authorities  to  harmonize 
existing  requirements,  both  of  law  and  procedure,  and  that  for  the 
future  careful  consideration  should  be  given  by  Congress  to  the 
preparation  of  a  permissive  federal  incorporation  act  for  railroads 
engaged  in  interstate  commerce. 

4th.  A  ny,  if  not  most,  of  the  abuses  connected  with  railroad 
securities  arise  out  of  an  almost  universal  failure  to  recognize  the 
distinctions  which  exist  and  should  exist  between  bonds  and  stocks. 
A  bond  is  an  obligation  to  pay  a  fixed  sum  of  money  at  a  stated  time. 
A  stock  certificate  is  merely  the  evidence  of  ownership  of  a  share  in 
the  property,  profits,  and  risks  of  a  corporation.  Most  of  the  evils  of 
which  investors  and  the  public  complain  have  grown  out  of  the  at- 
tempt to  give  to  stock  a  face  value  in  terms  of  money.    Even  if  the 


>S. 


il 


36 


BEPORT  OF  BAILKOAD  SECUBITIES  COMMISSION. 


State  laws  prohibiting  the  issue  of  stocks  for  less  than  par  were 
literally  enforced  all  that  the  recitals  on  the  face  of  a  fully  paid 
share  of  stock  as  to  its  par  or  money  value  would  signify  is  that  at 
the  time  of  the  issuance  of  the  share  there  had  been  paid  into  the 
corporation  an  amount  of  money  (or  other  valuable  consideration) 
equal  to  the  par  value  of  the  share.    They  do  not  even  purport  to 
indicate  that  at  any  time  after  the  original  issue  of  the  stock  the  cor- 
poration was  possessed  either  of  the  money  or  the  money's  worth. 
The  real  value  of  the  stock  certificate  depends  upon  the  manner  in 
which  the  money  has  been  invested.    The  Commission  is,  therefore, 
of  the  opinion  that  it  is  far  more  important  to  ascertain  just  what 
are  the  facts  connected  with  the  issue  of  securities  and  what  is  actu- 
ally done  with  whatever  money  has  in  fact  been  realized  from  the 
stock  which  is  issued,  than  merely  to  make  sure  that  the  par  value 
of  the  stock  was  paid  in  at  the  time  of  issue. 

5th.  If  we  were  compelled  to  assume  that  rates  are  to  be  mate- 
rially influenced  either  in  their  making  by  the  railroads  or  in  their 
regulation  by  the  Government  by  the  amount  and  face  value  of  the 
stocks  and  bonds  outstanding,  it  seems  to  your  Commission  impos- 
sible  to  escape  the  conchision  that  these  securities,  should  be  issued 
only  under  Governmental  regulation.  Your  Commission,  however, 
believes  that  the  amount  and  face  value  of  outstanding  securities 
has  only  an  indirect  effect  upon  the  actual  making  of  rates  and  that 
it  should  have  little  if  any  weight  in  their  regulation. 

In  so  far  as  the  value  of  the  property  is  an  element  in  rate  regu- 
lation the  outstanding  securities  are  of  so  little  evidentiary  weight 
that  it  would  probably  be  of  distinct  advantage  if  courts  and  com- 
missions would  disregard  them  entirely,  except  as  a  part  of  the 
financial  historv  of  the  property,  and  would  insist  upon  direct^  evi- 
dence  of  the  actual  money  invested  and  of  the  present  value  of  the 
properties.    For  this  and  other  reasons  discussed  in  the  body  of  the 
report,  your  Commission  recommends  that  the  Interstate  Commerce 
Commission  should  have  authority  and  adequate  funds  to  make  a 
valuation  of  the  physical  property  of  railroads  wherever  the  ques- 
tion  of  the  present  value  of  these  roads  is,  in  the  judgment  of  that 
Commission,  of  sufficient  importance.    It  is  hardly  necessary  to  add 
that  your  Commission  does  not  believe  that  the  cost  of  reproduction 
of  the  physical  properties,  however  carefully  computed,  is  the  sole 
element  to  be  considered  in  determining  the  present  value  of  a  rail- 
road, or  that  the  outstanding  securities  could  or  should  be  made  to 
conform  to  any  such  arbitrary  standard. 

If  railroad  securities  were  to  be  issued  only  after  express  authori- 
zation of  each  particular  issue  by  the  Interstate  Commerce  Commis- 
sion or  other  governmental  agency,  it  is  difficult  to  see  how  the  Gov- 
crnment  can  thereafter  escape  the  moral,  if  not  the  legal,  obligation 


REPORT   OF   RAILROAD   SECURITIES   COMMISSION. 


37 


to  recognize  these  securities  in  the  regulation  of  railroad  rates.  In 
view  of  the  vast  extent  of  the  railroad  systems  of  this  country  and 
the  magnitude  of  the  financial  interests  involved,  both  on  the  part 
of  the  railroads  and  of  those  who  pay  the  rates,  your  Commission 
believes  that  the  possible  consequences  of  such  a  system  of  regula- 
tion are  too  serious  to  warrant  its  adoption  at  the  present  time. 

6th.  Upon  the  whole,  your  Commission  believes  that  accurate 
knowledge  of  the  facts  concerning  the  issue  of  securities  and  the 
expenditure  of  their  proceeds  is  the  matter  of  most  importance. 
It  is  the  one  thing  on  which  the  federal  government  can  effectively 
insist  today ;  it  is  the  fundamental  thing  which  must  serve  as  a  basis 
for  whatever  additional  regulation  may  be  desirable  in  the  future. 
Respectfully  submitted. 

Arthur  T.  Hadley,  Chairman. 

Frederick  N.  Judson. 

Frederick  Strauss. 

Walter  L.  Fisher. 

B.  H.  Meyer. 


I 


»'t 


Kg^SVJBIHILIJT  r:  jy» 


INDEX. 


t 


11;  1 


Section.  I'apre. 

1.  Railroad  Securities  and  Interstate  Commerce 7 

2.  Present  Requirements  and  Future  Policy % 8 

3.  Theory  of  Railroad  Stock  Issues 9 

4.  State  Legislation  Regarding  Stock  Issues 10 

5.  Evasion  of  State  I^ws 10 

6.  Danger  of  Evasion  of  Federal  Law H 

7.  Enforced  Uniformity  not  yet  Attainable 12 

8.  Enforced  Publicity  Immediately  Needed 13 

9.  Mode  of  Procedure 13 

10.  Facts  to  be  Disclosed 15 

11.  Physical  Valuation 15 

12.  Results  to  be  Expected 16 

13.  Conflicts  of  Jurisdiction 18 

14.  Development  by  Intercorporate  Holding 1^ 

15.  Control  by  Intercorporate  Holding 20 

16.  Financial  Dangers 21 

17.  Alternative  Methods 22 

18.  Treatment  of  Existing  Issues ^  23 

19.  Price  of  New  Issues  of  Stock 24 

20.  Shares  without  Par  Value 25 

21.  New  Issues  of  Bonds 26 

22.  Dividends  and  Reserve  Funds 27 

23.  Treatment  of  Intercorporate  Holdings 28 

24.  Reasonable  and  Unreasonable  Expectations 29 

25.  Promoters'  Profits  and  Services 30 

26.  Standardization  of  Railroad  Securities 31 

27.  Restoration  of  Public  Confidence 32 

28.  Amount  of  Additional  Capital  Required 32 

29.  Present  Return  and  Future  Security 33 

30.  What  Constitutes  a  Reasonable  Return 34 

31.  Points  to  be  Emphasized 34 

39 


_i; 


if 

;^1 


!^ 


SUGGESTIONS  RELATING  TO  PUBLICITY,  INDICATING  POINTS 
UPON  WHICH  AMENDMENTS  TO  THE  ACT  TO  REGULATE  COM- 
MERCE MIGHT  BE  BASED. 

[This  Commission  has  not  considered  it  proper  to  present  a  formal  draft  of  a 

statute.] 

Every  railroad  corporation  subject  to  the  provisions  of  the  Act 
shall  file  with  the  Interstate  Commerce  Commission  on  or  prior  to 
the  date  of  issuance  of  anj^  stocks,  bonds,  notes  or  other  evidences  of 
indebtedness  payable  at  periods  of  more  than  twelve  months  after 
the  date  thereof,  and  now  or  hereafter  to  be  authorized,  a  certificate 
of  notification  in  such  form  as  the  Commission  may  from  time  to 
time  determine  and  prescribe  which  shall  show : 
First:  (a)  The  total  amount  thereof  authorized. 

(h)  The  number  and  amount  thereof  outstanding  prior 
to  the  date  of  such  certificate;  the  amount  thereof 
theretofore  retired;  the  amount  thereof  then  undis- 
posed of,  and  whether  such  amount  is  held  in  the 
treasury  of  the  corporation  as  a  free  asset,  or 
pledged,  and  if  pledged,  the  terms  and  conditions  of 
such  pledge.  » 

(c)  The  number  and  amount  thereof  then  to  be  issued  and 

whether  to  be  sold,  pledged  or  held  in  the  treasury 
of  the  corporation  as  a  free  asset;  if  such  securities 
are  to  be  sold,  the  terms  of  sale  if  a  contract  for  such 
sale  has  been  made,  and  if  any  part  of  the  consider- 
ation to  be  received  therefor  is  other  than  money,  an 
accurate  and  detailed  description  thereof;  if  such 
securities  are  to  be  pledged,  the  terms  and  condi- 
tions of  such  pledge. 

(d)  The  number  and  amount  thereof  remaining  unissued. 

(e)  If  the  issue  is  of  shares  of  stock,  the  certificate  shall 

also  show  the  par  value  thereof,  or  if  the  issue  is  of 

shares  of  stock  that  have  no  specified  nominal  or  par 

value,  the  number  of  such  shares,  and  the  number  of 

then  outstanding  shares  previously  issued. 

Second:  The  preferences  or  privileges  granted  to  the  holders  of 

any  such  shares  of  stock;  the  dates  of  maturity,  rates  of  interest  of 

any  such  bonds,  notes  or  other  evidences  of  indebtedness,  and  any 

conversion  rights  granted  to  the  holders  thereof,  and  the  price,  if 

any,  at  which  such  shares  or  bonds  may  be  redeemed. 

Whenever  any  securities  set  forth  and  described  in  any  certificate 
of  notification  as  pledged  or  held  as  a  free  asset  in  the  treasury  of 
the  corporation  shall  subsequent  to  the  filing  of  such  certificate  be 
sold  or  repledged  or  otherwise  disposed  of  by  the  corporation,  such 

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REPORT   OF   RAILROAD   SECURITIES   COMMISSION. 


corporation  shall  file  a  further  certificate  of  notification  to  that 
effect,  setting  forth  therein  all  such  facts  as  are  required  by  sub- 
division (c)  of  the  foregoing  first  paragraph. 

The  provisions  in  regard  to  certificates  of  notification  shall  apply  to 
notes  or  evidences  of  indebtedness  running  for  periods  of  twelve 
months  or  less,  and  to  the  pledging  or  repledging  of  stoclcs,  bonds 
or  other  evidences  of  indebtedness  to  secure  such  notes  or  evidences 
of  indebtedness  running  for  periods  of  twelve  months  or  less,  except 
that  such  certificates  may  be  filed  within  ten  days  after  the  issue 
thereof  instead  of  on  or  prior  to  the  date  of  such  issue. 

Every  such  railroad  corporation  shall  furnish  to  the  Commission, 
at  such  time  or  times  as  the  Commission  may  require,  in  addition  to 
its  income  account,  a  balanced  statement  of  its  receipts  and  expendi- 
tures on  capital  account,  and  of  the  surplus  of  the  income  account 
accruing  during  the  period  covered  by  such  statement,  as  well  as  of 
all  other  financial  transactions  that  have  taken  place  during  such 
period,  with  whom  had,  whether  in  cash,  in  securities,  or  in  other 
valuable  consideration. 

The  Commission  may  also  require  the  carrier  to  furnish  any  fur- 
ther statements  of  fact  or  evidence  that  it  may  deem  necessary  or 
appropriate. 

The  certificates  of  notification,  and  any  other  written  statement 
furnished  to  the  Commission  under  the  Act,  shall  be  signed  and  veri- 
fied by  the  auditor,  comptroller,  or  other  acting  fiscal  head  of  the 
carrier. 

It  shall  be  the  duty  of  the  Commission  to  enforce  these  provisions, 
and  to  make  public  by  appropriate  means  the  information  received, 
as,  in  its  discretion,  it  may  deem  proper;  and  such  certificates  of 
notification  shall  at  all  times  be  deemed  public  records  and  open  to 
inspection. 

The  Commission  may  also  require  the  carrier  to  compile  for  the 
information  of  its  shareholders  such  facts  in  regard  to  the  financial 
transactions  of  the  carrier  for  its  fiscal  year  in  such  form  as  the 
Commission  may  direct.  The  carrier  may  be  required  by  order  of 
the  Commission  to  disclose  every  interest  of  the  directors  of  such 
carrier  in  any  transaction  under  investigation.  The  Commission 
shall  have  the  power  to  investigate  all  such  transactions  and  to  in- 
quire into  the  good  faith  thereof,  to  examine  the  books  and  papers  of 
carriers,  construction  or  other  companies  or  of  firms  or  individuals 
with  which  the  carrier  shall  have  had  financial  transactions,  for  the 
purpose  of  enabling  it  to  verify  any  statements  furnished,  and  to 
examine  into  the  actual  cost  and  value  of  property  acquired  by,  or 
services  rendered  to,  such  carrier. 

Appropriate  penalties,  including  fine  and  imprisonment,  should 
be  provided  for  violation  of  these  provisions. 

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